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Turning Economic Threats Into Opportunities

| May 21, 2014

Much remains undone in the global economic agenda following the 2008 crisis. As a result, macroeconomic threats and opportunities abound on the path to 2025.

In a repeated, premature rush to declare the crisis over, the world is serially misreading the distinctions between short-run and long-run economic imperatives. National short-run stimulus efforts, while bold, have been unduly curtailed by long-run concerns about inflation and sustainability; as a result, these initiatives have been insufficient to push many advanced economies on to a path of ongoing growth. At the same time, global efforts to coordinate action on long-term, structural reforms have tended to unravel as countries and companies have pursued narrower, local short-term interests. As a result, there is a risk that short-run stagnation will be turned into a chronic condition that, by 2025, would leave the global economy on fundamentally unstable long-run ground. More …

A decade of middling domestic economic performance, weak global demand and mounting instabilities would have profound implications for life in Canada and its interests abroad. As a small, open, resource-exporting economy, Canada is particularly exposed to international policy mistakes. And at home, a decade of stagnation would likely fuel citizen detachment from the state, reducing the latitude for Canada to act boldly on the global stage.

This paper outlines how timidity in the short run and insufficient collaboration in the long run threatens to create persistent stagnation over the next decade. It also highlights some national strengths and weaknesses on which Canada could focus to transform some of these threats into opportunities.

1. We need a more stimulated short run

The withdrawal of monetary stimulus is premature

The February 2014 G20 communiqué underscores that the global economy remains sluggish, fragile and vulnerable to shocks. The nascent recovery underway is fundamentally driven by policy-makers and their stimulus efforts.

At the outset of the crisis in 2008, economic authorities worldwide reacted with swift and radical action. But since then, the world’s dismal scientists have uncharacteristically erred towards too much optimism in anticipating the end of the crisis. Stimulus efforts have been prematurely curtailed. Worldwide, there is a tendency to overweight signs of improvement and underweight indications of continued stagnation.

The US Federal Reserve is now in the midst of its third attempt to withdraw from quantitative easing (QE). Central banks in, inter alia, Europe, China, Australia and New Zealand have also allowed monetary conditions to tighten. In the UK, forward guidance was undone by falling unemployment.

After only a few months of tightening, macro-indicators are already recording weaker prints. Inflation continues to decline in many advanced markets. This shouldn’t be a surprise: balance sheets are still impaired, corporate deleveraging still has far to go, household deleveraging has not begun, excessive cash reserves are high, credit growth is weak, investment is constrained and employment is low. The implementation of Basle III’s enhanced bank capital requirements implies a further brake on near-term credit growth.

It is possible that the world has slipped into a ‘QE trap’: every time real economic indicators tick upward and the prospect of reduced monetary stimulus is discussed, market yields back up, monetary conditions tighten, and the circumstances that would allow for the withdrawal of exceptional monetary stimulus disappear.

The spectre of deflation is still with us

In fact, prices in many countries are signalling that the world is still enmeshed in the crisis. Although inflation recently edged up in Canada, this is an anomaly: in the US, Japan, UK and Europe, inflation rates continue to decline.

Monetary policy has virtually no additional room to move: nominal interest rates cannot be pushed below zero, and neither can real interest rates if deflation sets in. Forward guidance could be adjusted and inflation targets raised, but neither appears likely to have much impact in the short term.

Short-run monetary impotence has long-term implications. Unexpectedly low inflation produces an effective increase in real interest rates. Savings become more valuable, so consumers and companies sit on their cash and wait for prices to fall. Debts become more burdensome, cash-constrained borrowers get knocked closer to bankruptcy, productive capacity gets lost and unemployment remains persistently high.

Fiscal stimulus and structural reform: time for more

Monetary policy has been stretched to its limits in advanced economies. These countries need to return to fiscal stimulus and structural reforms to generate growth and put themselves on a long-term path to sustainability. With interest rates at historic lows and inflation weak, the prospect of public borrowing crowding out the private sector appears non-existent. And yet, fiscal policy in most advanced economies has been tipped toward austerity. Hard, medium-term fiscal targets were Canada’s signature 2013 G20 issue.

Granted, debt ratios across the industrialised world have increased since 2008 by 30 percentage points to around 105 percent of GDP. Such a big ramp-up in advanced country debt happened only twice in the 20th century, both times fuelled by wars; post-conflict growth recoveries quickly brought debt ratios down.

It seems obviously paradoxical, but advanced countries are likely going to have to borrow more to get these debt burdens down. If the industrialised world is in anything close to a QE trap, then low interest rates will not stimulate growth enough to reduce debt-to-GDP ratios. If exceptional monetary stimulus continues to be withdrawn, effective interest rates could move higher than GDP growth rates, worsening debt dynamics further. Demographic pressure on spending and tax bases from ageing populations will only make this dilemma more difficult in coming years. By 2025, advanced economies could be faced with average debt burdens of 150 percent of GDP, on par with today’s Greece; wide-spread and potentially destabilising restructurings would become likely. Fiscal stimulus, investment and structural reforms focused on enhancing productivity and growth appear to be the only way to create a virtuous path toward long-run debt sustainability.

Canada has an opportunity to point the world away from a long, slow slide to 2025. Having introduced inflation targeting, the country can lead the charge to keep monetary policy loose—perhaps by replacing inflation targets with price-level or growth targets, even on a temporary basis. Having retained its triple-A credit rating throughout the crisis, Canada has the credibility to advocate for looser fiscal policy. Canada is said to have—rightly—played a key role in brokering the February 2014 G20 commitment to boost global output by US$2 trillion over the next two years. Now it needs to make sure it happens.

2. We need a more collaborative and engaged long run

We all need to chip in

Focused structural reforms are needed over the medium term just as critically as increased fiscal stimulus in the short term—to raise growth and to maintain social cohesion in Canada and abroad.

The spike in joblessness touched off by the 2008 crisis has masked a secular decline in employment across many industrialised and emerging countries that began in the 1990s and has taken employment-population ratios down to their lowest levels in decades. This is not just a by-product of crisis-induced weaknesses in labour demand, but rather a supply-side issue: too few people have the right incentives to work, and an ageing workforce only makes this problem more acute. Taxes, entitlements and pensions need to be reformed to encourage people to accept employment and to facilitate women’s labour-market participation. Having made substantial reforms to the Canada Pension Plan and Old Age Security, Canada can help other economies undertake structural reforms to increase incentives to work.

More inclusive growth

In 2012, the World Economic Forum highlighted severe income inequality along with chronic fiscal imbalances as the most likely risks of the next decade. Across many advanced economies, these risks have already been realised. In Canada, the inequality gap is amongst the widest of its industrial-economy peers, owing in part to the fact that Canada’s tax and benefits systems do relatively less to mitigate this spread compared with other advanced countries.

jobs that carry far less generous pensions. As a result, they are less likely than their parents to identify themselves as members of the middle class.

Recent IMF (2011) research has found that inequality tends to be bad for growth. In fact, the IMF has argued the recent global financial crisis “may have resulted, in part at least, from the increase in inequality.” As inequality rises, the poor borrow to maintain their consumption patterns, which deepens macro-vulnerabilities. Severe inequality leads to underutilization of skills and capabilities, increased social and political instability, and reduced foreign investment. Corak (2013) has demonstrated that countries with higher inequality also suffer lower income mobility.

As younger generations move in to the electorate, the political pressure to address inequality and mobility issues will increase.

A stronger partnership with emerging markets

The year 2013 was to have been the first year in which emerging markets would account for more than half of global growth and world-wide production, but they got side-swiped by the Fed’s taper and sagging Chinese commodity demand. Commentators have tended to blame the victims, arguing that the worst hit emerging markets are those that wasted years of easy access to advanced-economy capital by accumulating big current account deficits rather than investing in structural reforms.

There are two problems with this line of analysis: first, it is needlessly antagonistic to the emerging partners Canada and other advanced countries will need to buy their debt and sustain developed-market growth in the years to come. Forty percent of the companies in the S&P500, for instance, are critically dependent on demand from emerging markets. Excluding China, emerging markets are running a cumulative current account deficit of around US$250bn that they have largely spent on advanced country exports.

Second, this line of argument is not supported by data. Since the outbreak of the crisis, historical determinants of capital flows have broken down and capital has tended to flow back and forth between developed and emerging markets in lock-step, driven almost wholly by impressions of global risk. Eichengreen and Gupta (2013) show that fundamentals in emerging markets have not provided insulation from these whipsaws.

Even worse, relatively large and liquid emerging markets have tended to experience more pressure because international investors can move in and out of them easily. In short, there is a penalty for success, which has prompted several emerging countries to press the IMF to soften its opposition to capital controls. In 2011, they succeeded. If this continues, international capital markets will simply become more fragmented, and global growth prospects will be put under greater pressure.

More flexible and effective international institutions

Emerging markets missed a chance during the crisis to renew our multilateral institutions. They held enormous leverage: Europe desperately needed fresh capital and emerging markets held about two-thirds of global foreign-exchange reserves. In return for financing Europe, emerging countries could have insisted on deep reform of the IMF, the World Bank and the WTO. Through the G20, they negotiated in 2010 increased voting power and more IMF Board chairs, as well as more resources for the Fund; however, they did not seal US Congressional ratification of this deal, and it remains in limbo.

The whole world loses if emerging markets are penalised for failing to seize their moment. Most immediately, the IMF will remain too small to be an effective firefighter. Many of the IMF’s lending arrangements since 2008 have been so large that the Fund has had to override its own credit limits. The implication is stark: if industrialised countries stumble in the years ahead, the IMF doesn’t have the resources to pick them up. There is no lender of last resort.

Both advanced and emerging market countries are already engaging in costly self insurance—by accumulating inefficiently large foreign exchange reserves, by creating standing swap lines between their central banks, and by creating regional alternatives to the IMF. While individually, each of these initiatives may help protect a particular sovereign, together they make the entire international system more prone to volatility. With the prospect of more advanced country debt restructurings in the years to come, the world needs a proper process for sovereign crisis resolution.

Canada has a seat at all of these policy tables. It should use these chairs to drive reform.

3. Concluding remarks

The next ten years present a multi-layered set of macroeconomic challenges for Canada and the world that will need to be addressed concurrently. In the short run, enough stimulus needs to be provided to get national and global economies to take-off velocity. At the same time, economic authorities need to begin engineering the conditions to sustain this growth over the long run. Finally, our international institutions need to be renewed to keep them legitimate and effective.

This post was originally published as a paper Commissioned by the Canadian Security Intelligence Service (CSIS) for Her Majesty the Queen in Right of Canada, as part of the 2014 CSIS Academic Outreach program titled Of Threats and Opportunities Exploring Canada’s National Security Interests in 2025 The Global Economy and Canada’s Place in It.

A Tale of Two Regions

The story of Nigeria is really the story of two Nigerias
| May 16, 2014

The news coming out of Nigeria of late is challenging the assertion that it is now the dominant state in Africa. The central line the government in Abuja appears to be pushing is of a state that is powerful, organized, and economically important to the region and continent. Instead of this taking root and the government being able to celebrate the country’s new-found status as the largest economy on the continent or its successful hosting of the African World Economic Forum meeting, however, it appears to be returning to a context of sustained instability. Persistent reports of massive corruption, recent bombings, and the kidnapping of close to 300 schoolgirls by the rebel group, Boko Haram, give the increasingly real impression that Nigeria is not on the right track.

This is only made worse with the lackluster and slow handling of the schoolgirls’ kidnapping by President Goodluck Jonathan and his officials. The sheer gruesomeness of the idea that many of the girls have been sold and forced into exploitative and abusive situations has captured many on the international stage and led to a powerful social media campaign to pressure the Nigerian government to take some sort of action, #BringBackOurGirls.  

But this event also symbolizes old tensions between the North and the South that have plagued Nigeria for decades. The divisions between these two regions has been the source of conflict and disruption following a civil war in 1967 and has been a key factor in why this former British colony has slipped between democracy and military dictatorship since independence. It can also be seen in how one part of the country is more economically successful than the other. The divide also cleaves along religious and ethnic lines, further exacerbating the situation. More …

Indeed, divisions between the largely Muslim North and primarily Christian South are so strong that there is an unwritten rule that the regions alternate every eight years between who gets to hold the Presidency. But this convention was challenged when the northern President Yar’Adua, died in 2010 before the end of his first term and southern Vice-President Jonathan assumed the presidency legitimately through a constitutional transfer of power and went on to win the next election. President Jonathan’s electoral success, however, has denied the Northern political elites their chance to govern. This has led to much resentment and accusations that Jonathan is ignoring the North in his efforts to develop Nigeria.

This political context has served to reinforce extremist groups like Boko Haram and its mission to overthrow the government of Nigeria and establish an Islamic state in the region. The organization has been successful at continuing to exist despite Nigerian military offensives as it slips back and forth across the border into Cameroon and Niger.  But it has also arguably been successful because the political focus has been directed more to the oil-rich South of the country and not to providing sufficient resources to counter the Boko Haram insurgency either via economic or military means in the North.

Boko Haram when translated into English means “western education is sinful” and maintains links to al-Qaeda. It is part of their modus operandi to attack shops and schools that oppose their fundamentalist message. As such, it comes as no surprise that they target girls seeking out an education. But what is surprising (if not shocking) is how little the government and military have invested in terms of preventing such attacks from taking place and in attempts to get the girls back. At one point, the military fabricated a story claiming that most of the girls had returned home and only retracted this once the families and school principal denied the reports.

No one can argue that with the reevaluation of its GDP, Nigeria has a sense of economic reinvigoration. But this means very little if the political leadership of the country does not address an insecure region within its borders. Indeed, not taking immediate and decisive action is part and parcel of a long and sad story of division in Nigeria.

For the Nigerian government to capitalize on the good economic news that presently exists, it will have to turn its attention to providing economic, social, and viable security assistance to the North. This will be no easy task and will require time, persistence, and, perhaps most of all, political will.

Time for Humility in Foreign Policy

| May 16, 2014

Social scientists like to have a lot of variation when they study something—this way, they can figure out which aspects of the situation are likely to be related with the outcome—war/peace; democracy/authoritarianism; free trade/protectionism. The good news about the Western involvement in Northern Africa and Southwest Asia is that we have seen many different kinds of efforts. The bad news is that the outcomes have been lousy. That is, we have pretty much tried every major policy option and they have all looked pretty bad.

Massive intervention? Check. Or check minus, as the United States with some friends in Iraq and NATO in Afghanistan has not been able to snuff out violence and build self-sustaining political institutions in either state as yet. While it may be too soon to call Afghanistan a failure, it is hardly a success story. The Taliban are hardly quelled and they engage in violence throughout the country with the Afghan security forces taking a serious beating. One piece of evidence for the success argument is that the Afghan army is still fighting, but real questions can be raised about whether it can sustain this effort given the toll they are taking. Meanwhile, in Iraq the U.S. surge combined with the Anbar Awakening to temporarily reduce the level of violence in the country. But the surge was temporary and the Iraqi government largely betrayed the Sunnis who sided with the government. More …

Use air power to facilitate regime change? It actually worked in Libya because there were domestic opposition forces on the ground. But, as in Iraq and Afghanistan, breaking a government is one thing while building a stable, adequate government is something else. By doing the least it could do, NATO helped oust the Libyan government (despite a UN mandate that was focused solely on civilian protection). It could then walk away and let someone else deal with the aftermath and did so. However, while NATO can call its operation a success, the bloody aftermath suggests otherwise. Not only did instability lead to a tragedy for the United States in Benghazi, but has also led to trouble in the region, as evidenced by Mali’s problems over the past couple of years.

Do nothing? We have witnessed that with Syria. While there has been some arming of the opposition, no significant military intervention from the exhausted and increasingly frustrated West has been forthcoming despite ‘red lines’ being broken and civilian deaths being widespread. And it has worked really poorly for the Syrians. Now, Assad’s grip on the government is not as fragile as we thought. Moreover, if and when he eventually does leave power, his opponents appear likely to continue their fight with each other.

Thus, we have strategies ranging all to nothing producing the same outcomes: failed states, inadequate governance, continued terrorism (though not hitting North America as yet). What can we draw from this “perfect” dataset?

First, there are almost always other outsiders who will work against state-builders. Pakistan and Iran did much to undermine state-building efforts in Afghanistan and Iraq. Russia, Iran, and various Gulf States are doing much to pursue their own respective interests in Syria that are in direct conflict with each other. Outside intervention works best if the international community lines up on one side and only one side, which largely distinguishes Bosnia in 1995 and Kosovo in 1999 from the cases discussed above.

Second, local allies have more important interests at stake than those of the international community. While the United States wanted the Iraqi leadership to make and keep its agreements with those who led the Sunni Awakening, the Iraqi government under PM Maliki had its own political interests. Similarly, President Karzai has always had his eye on what was best for himself and not so much for what NATO thought was best for Afghanistan.

Third, force simply has limited utility. We cannot kill our way to good governance and popular support. The United States and its allies are adept at breaking governments; but legitimacy simply does not flow from the barrel of a foreign gun. Much of the hard work in Afghanistan, Iraq, Libya, and Syria necessary for lasting peace involves politics and governance rather than the deployment of violence. These are activities that outsiders do poorly in general given their lack of understanding for local context and force them into doing things that they are particularly bad at: working as coherent efforts with various bureaucracies (defence, foreign affairs, etc) cooperating.

The take home lesson is that we (as an international community) need to have a bit more humility. Outsiders can facilitate regime change but not political stability, let alone democracy, prosperity, and the rest. There is a role to be played by armies, navies and air forces, but their utility is limited and this limitation needs to be understood by the policymakers that call for their use. While U.S. Senator John McCain cannot help but advocate for the use of force in pretty much every possible situation, the rest of us need to look at the recent events with clear eyes. I am not sure if the Hippocratic oath needs to be applied—first, do no harm—but we need to be more realistic about what we can accomplish and how we can accomplish it.

Sometimes we must do something because the alternative is worse, but doing something may not be all that good either. In these and other cases, we must ask ourselves what represents the least worst outcome and how do we get there. It may be the case that there is little that the outsiders can do.

The End of the Beginning in South Africa

| May 14, 2014

The ruling African National Congress (ANC) has secured another term in national office after the 5th, free, fair, and straightforward election in a democratic South Africa.  Indeed, the ANC ran on a platform of a “Good Story to Tell” that focused on the past achievements of continental Africa’s oldest liberation party. This narrative permitted the ruling ANC to sidestep the moral and ethical questions that have surrounded them as of late.

To those unaware, President Jacob Zuma was recently implicated in a misappropriation of public funds scandal relating to his private residence. Moreover, this is but one of a number of questionable circumstances that have called into question the moral compass of ANC officials. Following these allegations of corruption in combination with the fact that many feel that the socio-economic gains made post-Apartheid have been marginal, it is surprising that the ANC is back in power in Pretoria with majority governments in all provinces but one, the Western Cape. More …

But this election was actually never about the defeat of the ANC. It was about making marginal gains that place the ANC within striking distance for South Africa’s other parties. These marginal gains could have included unseating the ANC as government in some provinces, as I mooted in a previous Roundtable contribution, but it was primarily about diluting the ANC’s voter base and making gains in areas where opposition parties have typically held little traction.

Indeed, the interesting story of this election is the rise of opposition parties rather than the ANC’s continued hold on power. In particular, the gains and consolidation of most votes against the ANC into two opposition parties represents a large shift in South African electoral politics. Despite the fact that there were 29 parties contesting the South African election, only 13 will be represented in Parliament with the Democratic Alliance (DA) and the Economic Freedom Fighters (EFF) securing 114 out of 151 oppositional seats.

The official opposition party—the DA—made significant steps in terms of its share of the popular vote. Nationally it reached just over 22 percent (up from 16 percent in 2009), which translates into 89 seats in the current Parliament; it held its control of the Western Cape (where Cape Town is the major metropole) with an increased majority; and came within striking distance of unseating the ANC in South Africa’s economic engine, Gauteng (where Johannesburg rests).

The fledgling Economic Freedom Fighters (EFF) party made a good showing taking the official opposition post in a number of provinces and securing 25 seats in Parliament. This is impressive given it was its first election and its performance was no doubt helped by the recognition its popular leader and former ANC Youth League President, Julius Malema. The big question regarding the EFF will be if they have the organizational capacity to capitalize on their gains and to secure its voter base in subsequent votes.

In Canadian terms, this might all seem rather inconsequential and uninteresting, with the ANC still in power. But for South Africa, this election has demonstrated that the seeds of political change are taking root and that the emergence of a true multiparty democracy in which parties actually contest for power is taking place. Indeed, in Gauteng the ANC held onto its majority position by only two seats in the provincial legislature. This is a big shift from 2009 when the ANC got 64 percent of the popular vote in South Africa’s most populous province.

One thing I have learned during my time in this young democracy is that electoral politics is very much about the long game and adapting to the shifting demographics. The ANC has had 20 years in power—and has secured another five—largely based on the ability to draw on an image as the liberator of the oppressed majority.

In this sense, the ANC does have a good story to tell.  But the story of liberation and emancipation will only have relevance for so long. The generation of the so-called “Born Frees” is now maturing politically and they maintain different interests to that of liberation politics. The ANC will have to find a new narrative if it wishes to be relevant to this important electoral constituency.

At the moment, opposition parties are capitalizing on the frustrations that this new generation of voters maintains as well as concerns over corruption and cronyism, job creation, and equal opportunity.

So while the ANC is secure for the next five years, it will be a time of real political contestation as the stakes for holding onto political power are far greater than they have ever been.

Is Canada Pulling Its Weight in NATO?

| May 9, 2014

When NATO’s military commander, General Philip Breedlove, visited Ottawa this week, he noted that Canada was one of the first countries to contribute military equipment and forces to NATO’s temporary deployment of land, sea and air assets to Eastern Europe, where allies such as Poland and the Baltic countries are understandably nervous about Russia’s actions in Ukraine.

The Conservative government deserves credit for these actions. NATO must demonstrate that it remains committed to the security of all its members, and these “reassurance” measures help to send this message, both to our allies and to Russia.

Beyond this particular crisis, however, the alliance also relies on all its members to maintain military capabilities that can be used for collective operations. Without these capabilities, the deterrent effect of NATO – its ability to dissuade others from threatening the security of alliance members – will erode. More …

This is why NATO has long called upon its members to maintain military spending at 2 percent of GDP. However, few alliance members have met this target.

The latest spending figures indicate that Canada is actually one of the worst offenders. In 2013, only five other NATO countries spent a lower percentage of GDP on defence (see Figure 1).


Canada is also a member of the G7, a privileged club of established, industrialized nations. Figure 2 indicates that Canadian defence spending is lower, as a percent of GDP, than that of all other G7 members in Europe, including financially-strapped Italy.


These figures need to be treated with some caution: spending does not necessarily translate into quality. Canada has small, highly competent, deployable forces. We also have a track record of making modest but effective contributions to NATO’s joint operations, from the Balkan crisis of the mid-1990s to the missions in Afghanistan, Libya, and now in Eastern Europe.

But let’s not fool ourselves. Continued reductions in defence spending will have an impact on the quality of the forces that Canada can deploy in the future.

This is the challenge facing all NATO allies. Military spending is going up everywhere in the world except in North America, Europe and Oceania – namely, the West. This is worrying.

To be sure, addressing global security challenges will require more than capable military forces, as the US debacle in Iraq made amply clear. It will also require skilled diplomacy, the ability to build and manage relationships with both partners and adversaries, a willingness to adjust global institutions to reflect the rising importance of non-Western actors, and a recommitment by all Western states to upholding the rule of law, not just rhetorically but also in their actions.

But it will also require strength, including military heft, to back up the diplomacy. If the West and NATO continue disarming (which is effectively what they are doing, relative to others), we will find ourselves in a much more dangerous world in the not-too-distant future.

The case for government spending is always difficult to make in times of fiscal strain. Today, the economies of North America and Europe are facing slow growth and many competing demands. Nevertheless, we would be foolish not to invest in our diplomatic and military capacities now. If we fail to do so, we risk paying a much higher price later.

Considering Defence Procurement as Industrial Policy

| May 6, 2014

Last week, I testified before the Standing Committee on National Defence on a variety of issues related to North American security. One of the points I stressed is that making decisions about defence programs based on industrial benefits is problematic, especially at a time where defence spending is flat or even being cut. The Chair of the committee asked me to provide a short memo outlining the benefits and the costs of such a focus, as he clearly favours such an approach. Below, you will find my response to this request. More …


  • A small number of jobs will be created, some somewhat permanent and some temporary.
  • Developing equipment tailored for the needs of Canadian forces is better than Canadian-izing foreign equipment.
  • Some self-sufficiency in defence manufacturing.
  • Less dependency on allies and others for urgent repairs/upgrades.
  • Canada temporarily re-energizes dormant ship-building industry.
    • After this wave of ships is built, Canada will not need new ones for another 20-40 years, so the shipyards will again become dormant unless they can somehow become more efficient than shipyards elsewhere—which is unlikely. Unless Canadian shipping companies are heavily subsidized, they are unlikely to buy Canadian-built ships, which means more tax money spent on relatively few jobs.
  • Greater public support for defence spending.


  • Due to limited Canadian capacity, delays in ship-production will be inevitable.
  • Canada spends more money for less military capability. The markup on buying domestically is far greater than 10 percent. So, Canada gets less bang for the buck, which is not a good deal for taxpayers.
    • With the potential exception of F-35 technology, there are few economies of scale.
    • In times when the defence budget is increasing, this extra cost could be affordable. But now?
  • There are far better investments Canada can make in the economy that have greater multipliers for jobs, taxes, and industry than defence spending. There is plenty of scholarship demonstrating that military spending, while having some positive spinoffs, does not produce as much of a multiplying effect as other investments, such as education.
    • Some companies may be incentivized to get into businesses for which they are poorly suited and then find themselves out of luck when partnerships do not materialize.
    • Many of the specialized skills for defence contracts do not translate to civilian projects, limiting the afore-mentioned multiplier/spinoff effects.
  • Using defence procurement as a jobs program is bad for Canadian politics. It will distort spending as defence contractors will develop programs with an eye on which ridings matter most to each party. This might be good for winning some votes, but it then means that procurement decisions become even more politicized. Parties will compete for votes by choosing their favoured programs. This will move defence procurement decisions further away from what is best for Canada and towards what is best for particular parties.
    • One of the advantages Canada has over the United States is that party loyalty means that parties are not as compelled to direct government spending to particular districts, which tends to produce inefficiencies (pork). Seeing defence spending as pork is bad for good governance and bad for the military. They end up getting weapons they do not want or need—and then don’t get the weapons they do need.

The aerospace industry argument is somewhat different since Canada actually has some success and capability there. Given the nature of the competition between the various contenders, each one promising industrial benefits, Canada will receive investment from international competitors, so the focus really should be on what plane is best for the Canadian Air Force.

Ultimately, Canada is going in the direction of the plan outlined by the Harper government. I don’t like it because I think the focus of defence spending should be on getting the maximum defence bang for the buck rather than focusing upon where the material is sourced. With that said, I understand the politics of it. So, if Canada does make decisions based on “industrial benefits,” I simply recommend understanding that this means Canada gets less and prepare for it by cutting personnel, bases, and whatever else that is premised on a larger military. Of course, these cuts may hurt the Canadian economy (and voters) more than industrial benefits help.

Canada’s Strategic Dilemma

| May 1, 2014

This column is drawn from Steve Saideman’s opening statement for his testimony on May 1, 2014 before the Standing Committee on National Defence.

The starting point for any conversation about Canadian security is that Canada is in a rare position in the world: geography limits the threats Canada faces while its economic strengths and political stability mean that Canada is quite secure compared to the rest of the world.

While there is much talk about terrorism, cyber, and other unconventional challenges, the reality is that Canada is secure enough that it can make mistakes without paying too high a price. This is a good thing since Canada tends to make mistakes because its politicians refuse to face the tradeoffs and make the hard choices needed to confront the changing realities of 21st century defence. Of course, mistakes can be still be quite serious as they can endanger Canadian soldiers, pilots, and sailors. More …

To be clear, many of the defence procurement challenges are neither new to Canada nor the fault solely of the current government.  That Canada is facing re-capitalization of its navy while having to purchase replacements for the core of the Air force is a real problem.  In my family, we try to only buy one car at a time and space those purchases out so that we are only paying one car loan at a time… until a school bus rammed my younger car.  In the case of Canada, the lifespan of the ships and planes was entirely predictable, so it should not have been the case that Canada needed to replace all of its ships, planes, and Arctic patrol vessels at the same time. Even if the way the accounting works for defence allows for multiple projects simultaneously, Canada has not yet proven that it has sufficient expertise inside government to manage multiple programs simultaneously. And, clearly, we do not have the shipyard space to be building many different ships at once.

Still, this government has been in office for quite a while yet it refuses to face the tradeoffs that must be addressed. The best example of this is the notion that more than CAD$3 billion can be cut without any consequences. But the most important and least necessary denial of reality is this: keeping troop levels to a symbolic level of 100,000 people is costly and almost entirely unnecessary. Personnel costs are a huge part of the budget, so one should cut there as well as in other places.

The refusal to do so, combined with the large procurement projects, means that cuts will fall on operations, maintenance, and exercising—each of which are integral to operational success. In the United States, there is always concern about the hollowing out of the force—that there will still be a large amount of equipment and many soldiers, sailors, marines, and pilots—but they will lose their sharp edge due to a lack of practice. This is what is going to happen in Canada.

Here, these consequences are being ignored for the symbolism of being strong on defence by keeping the force at 100,000. Experts know that the government in Ottawa today is spending about the same as it was spending in 2006 once you control for ordinary inflation. The problem, of course, is that inflation in military equipment is hardly ordinary.

A flat budget is problematic when inflation is significant. Exacerbating this is the move to emphasize the “industrial” benefits of defence programs so that systems built in Canada are advantaged in competitions over those that do not lead to Canadian jobs but are cheaper and/or more effective. The shipbuilding program seemed like a good idea—have a nation-wide competition to decide where in Canada the ships are built. The problem is that restarting long dormant shipyards means that Canada will be paying a premium for these ships—and a hefty one at that. The ships will be much more expensive and almost certainly less capable than those made in Europe or elsewhere. This will almost certainly mean fewer ship, which means that the Department of National Defence (DND) should be thinking now of what a smaller navy means, including what kinds of cuts can be made to the number of sailors, since fewer ships should mean fewer sailors.

Of course, this speaks to an enduring problem—Canada’s military should be designed to fit Canada’s strategy—an assessment of the threats Canada faces, the means by which those threats will be dealt with, and the balancing of commitments with capabilities. Unfortunately, the Canada First Defence Strategy was overcome by events years ago.

A new strategy that takes seriously the fiscal constraints and the increased costs of equipment would recognize that Canada will have to do less with less, including a smaller army, a smaller air force, and a smaller navy. Canada can still be a good partner in NORAD and a good ally in NATO as long as the forces it contributes to various missions are not hollow—small is better than hollow.

Rather than cutting by default and by accident (literally in the case of the Navy), Canada can and should make the difficult—and strategic—choices. This government is actually in an excellent position to do so, since, here is where I display my political science, the opposition parties are unlikely to pick up votes from those who want more defence spending.

To be sure, these problems are not unique to Canada, as most advanced democracies face similar problems: tighter budgets, defence procurement “challenges”, and alliance commitments. Of course, Canada can choose the traditional path—which is to muddle through—but this time, the stakes are higher since the programs are so very expensive while all of this is coming to a head at the same time.

A Principled Approach to Russia

| April 25, 2014

When one gets an invite to take a paid trip to Paris for a few days, one tends to say yes. The German Marshall Fund is hosting an event on Transatlantic Security this week and after just the first dinner of the conference, I have reached the conclusion that this trip is worth my time, the jet fuel, and even the carbon emissions. Why? Well, the event is off the record so I cannot get into details, but the evening’s dinner centered on the crisis in the Ukraine and between Russia and NATO/EU/the rest of the planet. And the conversation tonight among people far smarter and better connected (most do work or have worked for various governments and international organizations) led me to thinking about two basic dynamics: the short term vs the long term view of foreign policy and the intrinsic value of Ukraine vs. larger principles. More …

Someone suggested that Putin has won the battle but is likely to lose the war, if one thinks about Crimea versus the larger effort to return to “Great Power”/influence status. This and other comments got me thinking: democracies and alliances tend to be less agile than authoritarian leaders (Russia’s democratic status is a wee bit suspect and electoral politics does not really seem to be motivated Putin), so they get out-maneuvered at the start of a crisis. However, democracies tend to win the wars they fight and alliances have often been on the winning side of things for much of the past two hundred years—from Napoleon’s defeat to both World Wars to the Gulf War of 1991.

Why? Well, democracies might just be more selective about the wars they fight since politicians hate to lose elections. A different logic is that democracies can extract more resources and fighting power from their societies because legitimacy and representation work better than coercion in these endeavours. Yet a different logic might be that advanced democracies have “better” civil-military relations—coups can be mighty distracting to the task of governing. Alliances do well in wartime because more is more—combining the power of multiple countries may not be so efficient, but even quarreling allies may accumulate more combat power than countries largely operating on their own.

So while we can be very frustrated with how things have played out thus far, we might have good reason to believe that Putin’s momentum will eventually ebb. Indeed, once we take into account the other dynamics, it becomes not just a hope but pretty logical that Putin’s Russia may face some serious constraints as the situation in eastern Ukraine plays itself out.

The second dynamic is when we think about the worth of a place (even thousands of miles away) and the status of a conflict. Remember, the United States was committed to Bosnia not because then-President Bill Clinton cared about Bosnia but because he made a commitment to two NATO countries, France and Britain, that he would deploy 25,000 U.S. troops to extract them if needed. Once that became a real likelihood, Clinton chose to use those troops to enforce a peace instead. The Kosovo air campaign was almost entirely about maintaining NATO’s credibility rather than about the plight of Kosovars. Indeed, NATO members also bled in Afghanistan not so much because they cared about Afghans but because they were keeping their commitment to a NATO partner that had been attacked.  We find repeatedly that countries spend vast amounts of money, risk the lives of their soldiers, and even some political careers because the alliance itself is valued.  That is what should assure the Baltic States and Poland now. For Ukraine, there is little comfort in being outside of the NATO alliance.

But there is a larger principle that Kyiv and its friends ought to highlight during the current episode of violence and Putin’s power play: the death of the Helsinki Accords. In 1975, the Helsinki agreement between the United States, the Soviet Union, and Europe recognized existing boundaries and essentially produced a settlement from the Second World War. The key ingredient was that force could not be used to change boundaries. Of course, force has continued to be used to change boundaries—secessionist movements that use violence fit in this category. However, since Helsinki, no country in Europe has used force to change boundaries and gotten away with it except irredentist Armenia and, well, Russia over Georgia, Abkhazia, and now Crimea. Still, the recent events are perhaps more blatant and some people in the room tonight suggested that Helsinki might, indeed, be dead.

It seems to me that highlighting the death of this seminal agreement should be used as a mechanism to dissuade Russia of further encroachment in eastern Ukraine. Most countries in the world are opposed to the use of force to change boundaries since they see themselves as being on the losing end of such transactions. This is something that three of the BRICs can agree upon—India, China, and Brazil (China sees Taiwan and various islands as already theirs), as well as much of the rest of the world. Recognizing Russia’s irredentism would serve to isolate Putin just a bit more. Of course, there are differences among countries how best to penalize Russia (and for how long). But tying Putin’s efforts to Helsinki is more likely to attract support from countries that have no real history, relationship, or interests in Ukraine on the basis of the inviolability of sovereignty.

And this is where democracies, alliances, and principles might fit together. Democracies often have different interests including their varying dependency on Russian imports, but they share “values.” NATO is not just a military alliance but also of coalition of the like-minded. So, perhaps one way ahead to win the longer, larger war is to focus on the principles that bind us rather than the interests that might divide us.

The Least and Most Canada Can Do

| April 21, 2014

Canada is joining its NATO partners in sending six CF-18s to Eastern Europe (with some uncertainty on exactly where despite references to a specific base in Poland) and 20 CF personnel to help staff NATO headquarters. This is both ordinary and remarkable.

It is ordinary in the sense that Canada has signed onto every NATO mission, as far as I can tell; from defending West Europe from the Soviet Union, deploying into Bosnia, dropping bombs on Kosovo, participating in various missions in Afghanistan to dropping bombs on Libya to now defending Eastern Europe from Russia. That is pretty consistent. Six CF-18s are also the standard Canadian package for NATO reassurance. Up to now, this package has been delivered, as it were, to Iceland, as Canada has taken a few turns in the NATO mission of flying fighter planes over that otherwise defenceless NATO member. Now Canada is doing the same thing but much further to the east. More …

However, the deployment is also remarkable in that this mission is clearly aimed at sending a variety of signals to both Ottawa’s allies and the international community writ large. It is meant to be part of a NATO effort to remind Russia that countries that are members of NATO are untouchable. As an alliance, there is no commitment to defend Ukraine, but there is a strong commitment to defend Poland, the Baltic Republics, and the rest from the “old and new” threat to the East. It is also meant as a reassurance package, to signal to these eastern members that there is a big line between them and Ukraine—and that they are on the safer, guaranteed side of this line. Sending these planes is also a signal in Canada to Ukrainian-Canadian voters that Stephen Harper and John Baird seem to have been playing towards.  These planes do little to help Ukraine but given the rhetoric of the past few weeks, it was the least the Harper government could do.

This package of planes and a small staff also makes sense when thinking about the biggest priority for this government—minimizing expenses.  This government cares most about balancing the budget to meet its 2015 election commitment, so a larger intervention is unlikely. Indeed, sending a battalion for months on end would be prohibitively expensive. 

The deployment is also remarkable in another way—it represents a reversal of sorts for Harper. Canada has pulled out of a few collective efforts at NATO—to run the AWACS plans, to develop and operate drones—and has been viewed by some Europeans as being almost hostile to the alliance. Embracing NATO now makes sense given the positions staked out by Harper and Baird on Ukraine while also serving as a shift from recent behaviour.

One of the closing lines I often give when I talk about the new book on NATO in Afghanistan is an adaptation of a quote from former British PM Winston Churchill: “NATO is the worst form of multilateral military cooperation except for all of the others.” In light of recent events, even the Harper government has realized this. While NATO presents many difficulties including uneven burden-sharing and the likelihood of being lost in the cacophony of members with their various complaints, it is still the best organization for most security issues. So, Canada does what it is expected to—about as much and as little as it can do.

The IMF: Crisis Fighter

| April 16, 2014

In the run-up to the 2014 Spring Meetings of the IMF and World Bank in Washington, DC, debt-relief campaigner Jubilee Germany (‘Erlassjahr’ in German) posed the following questions to a few veterans of efforts to improve the way the world handles countries’ financial troubles:

Can the Fund play a positive role in a reformed process of sovereign debt restructuring or is that ruled out because it is a creditor? And if so, what could or should be its role in both the reform process and any new mechanism to handle sovereign debt crises?

The International Monetary Fund (IMF) unequivocally can and does play a positive role in the process of continual reform of the global financial system and our methods of dealing with sovereign financial distress. As the pre-eminent global centre of crisis-fighting expertise and macroeconomic policymaking, the IMF must continue to occupy a central position in our collective efforts to achieve and maintain global financial stability and growth, and in the means by which we resolve crises when they arise. More …

For decades, the IMF has been a key player in improving the way the world handles sovereign debt workouts. From the Bretton Woods-era onward, the raison-d’être of the IMF has been the provision of financing and counsel to ease the process of closing balance of payments gaps. Indeed, the adjustment process for most countries would have been substantially more difficult in its absence.

Since the end of the Bretton Woods system, the gaps the IMF has been called on to fill—gaps in both policies and financing—have grown larger while the IMF’s firepower has expanded slowly. If the IMF hasn’t always been up to the tasks set for it, then it is to some extent a reflection of a variable commitment to multilateralism on the part of its major shareholders.

And yet, the IMF still represents an essential public good: it highlights vulnerabilities, works to provide early warning of incipient crises, provides mutual insurance against financial trouble, collects an institutional repository of best practice in several policy realms, and conducts meaningful and practical research. When a country falls into crisis, the IMF’s well-developed approach to debt sustainability analysis allows it to assess a reasonable balance between adjustment and debt relief, and convene stakeholders to implement the required policies and financing to restore a country to market access. No other institution or collection of experts is better placed to support our efforts to build what Christine Lagarde recently called “A New Multilateralism for the 21st Century.”

It was lamentable that the U.S. Congress didn’t ratify the G20’s agreed reforms of the IMF’s quota system back in January. But let’s put this miss in perspective: under any quota formula that has been institutionalized in the past or proposed for the future, the American quota is smaller than the United States’ role in the global economy implies it should be. Yes, the Fund’s governance must be re-weighted and improved, but even unreconstructed, the IMF still represents a subordination of national self-interest for multilateral good.

The IMF’s engagement in reform of the international system is hardly compromised by the fact that it provides debtor-in-possession financing. In fact, the extent and meaning of the IMF’s role as a creditor is vastly overblown. IMF lending represents only a small portion of the financing in most IMF-supported programmes and IMF arrangements are not intended to fill a country’s external financing gap. Instead, IMF funds are meant to catalyze co-financing from other official multilateral and bilateral sources, as well as from the private sector—and that is what they do.

This dependence on other creditors doesn’t make the IMF captive to their interests. Private creditors consistently view IMF programmes as tipped toward debtor interests. They see a presumption toward debt restructuring over adjustment in the IMF’s responses to its members’ financing challenges. Meanwhile, private creditors see Paris Club terms agreed without their participation and imposed upon them by bilateral public creditors under expectations of comparable treatment despite the fact that they don’t have a seat at the Paris Club’s table.

The IMF’s April 2013 Board paper, which reopened the Fund’s discussion on sovereign debt workouts, posited a series of changes that would limit creditor interests further. Amongst other things, the paper raised the possibility that delayed payments to bilateral creditors could be tolerated under the IMF’s “lending into arrears” policy. It also raised the possibility of making IMF financing contingent on automatic debt restructuring under defined circumstances. And finally, it discussed the need to make collective action clauses in bond contracts more effective in binding creditors to the terms of debt restructurings. These are not the proposals that would be floated by an IMF captured by either private or bilateral creditor interests.

To summarize, the IMF is not only expressly designed to play a role in continually improving the world’s efforts to maintain financial stability and growth, but it also can point to a good set of precedents in which it has made major contributions to this process. In this context, the IMF should clearly continue to be involved in global reform efforts.

Nevertheless, it’s premature for anyone—not least the IMF—to discuss renewed proposals for a mechanism to deal with sovereign debt. Since the rejection of the IMF’s Sovereign Debt Restructuring Mechanism (SDRM) in 2003, there has been no sign of renewed global appetite for a statutory sovereign bankruptcy court or a binding arbitration process, based either at the IMF or elsewhere. Given that it has proved impossible to secure even minimal IMF quota reform, it is, frankly, a folly to push now for renewed consideration of a statutory mechanism to restructure sovereign debt. In this context, the IMF shouldn’t be involved in either drafting such a proposal or in its putative operations. The IMF should, instead, be focused on the art of the possible—on articulating reforms that could have a meaningful impact and that could actually be implemented.

At present, such reforms include improved model language for bond contracts that provide for better collective action clauses, more effective aggregation, and sovereign commitments to engagement and transparency with creditors. The IMF should also work on refining decades-old proposals for model forms of state-contingent sovereign bonds that would allow for debt service suspensions and/or automatic maturity extensions during times of macroeconomic distress. Finally, the IMF could play a critical role in helping sovereigns and their creditors come together more proactively to address incipient signs of distress through venues such as the proposed Sovereign Debt Forum (SDF).

The IMF has an important role to play in refining and promoting these three sets of reforms, but that role does not yet—and may never—involve the creation of a statutory debt restructuring mechanism.

This article also appears in German in the Jubilee Germany (Erlassjahr) Debt Report (Schuldenreport) 2014. Brett House will be speaking about the global implications of public debt and what can be done to offset a major crisis at a CIC Montreal event on April 16.

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