Budgeting & The Options

October 9th, 2012 by De Onion

There are 4 options for Bermuda (or a combination)
1. Austerity – cut spending to live within our means in an orderly fashion. This can either be done now with severe implications to Bermuda, or it can be done later with even more severe implications. The longer we wait, the worse it gets. The PLP has already begun this process, but too little, and far too late – meanwhile it’s attacking the OBA for proposing exactly what the PLP is already doing.
2. Growth – This would involve radical reversals of many policies, especially term limits and immigration. Even then it probably wouldn’t be enough to balance budgets and begin to pay our way out of the hole.
3. Bankruptcy – Disorderly and immediate cuts to the government as it loses access to capital markets.
4. Tax increases – These were tried in 2011 with the Payroll tax and then reversed. The current size of a tax increase needed to balance the budget without cuts is equivalent to approximately $7,500 per working person in Bermuda.
To have tried and reversed #4 and is attacking the OBA for mentioning #1 and #2 we can only assume that the PLP is favouring #3: Bankruptcy. No matter which one is chosen, Bermuda will face serious negative consequences and constraints for decades.

Other clearly false or misleading talking points making the rounds:

Claim: The deficit exists because of recession induced revenue shortfalls. This isn’t true because: Revenues increased by hundreds of millions of dollars between 2004 and today, and large deficits started years before the recession. There has been a consistent upward trend in revenue right up until 2010. If the deficit was caused by revenue shortfalls then we would expect it to start in 2010, not 2006.
In fact, if revenues had been at expectations instead of much higher then deficits would have started years earlier as can be seen comparing the budgeted amounts from the actual in the following reports:
http://www.pwc.com/bm/en/bermuda-budget/2004.pdf
http://www.pwc.com/bm/en/bermuda-budget/2005.pdf
http://www.pwc.com/bm/en/bermuda-budget/2006.pdf
The trend of overspending was established in 2004, 2005, 2006, 2007, 2008.

Claim: The Bermuda recession was caused by the Great Recession. This isn’t true because: Jobs didn’t disappear, they moved. Jobs only disappeared in the local economy because we lost the people who bring money into the island – the 365 day a year tourists. The drop in expatriate population and in workforce size makes this absolutely clear. Aside from tourism, Bermuda’s main lines of business were unaffected by the recession. Even tourism has since recovered in other countries, but not in Bermuda.

Claim: Bermuda continues to be impacted by the Global Financial Crisis. This isn’t true because: Bermuda’s main industries were only very temporarily affected and have since recovered while Bermuda continues in a downward spiral. We also had none of the issues that are currently causing other countries to fall into recession such as a real estate bubble (our boom was not a bubble because houses were still fairly valued vs. rental yields), we had no banking crisis, and we did not lose a major pillar of our economy like other countries in crisis.

Claim: Investment vs. Austerity. This isn’t a debate. Austerity is inevitable and every year of deficit spending it will be more severe (because they are adding on to the interest payments that need to be made). it’s possible that we could avoid severe cuts in government spending, but only by repealing policies that have caused the recession. Every year we spend before we face the inevitable we are burdening ourselves with ~$15 million more in interest costs, that = ~150 jobs lost.

Claim: Paula Cox has been right on the economy. This is not true. Virtually every time she has opened her mouth on the state of world affairs she has been dead wrong – from her claims of a “post recessionary environment” to her claims that “fears over the euro have largely subsided” literally the day the Financial Times ran a headline about bond spreads (a measure of fear) jumped dramatically. Meanwhile, those who have been right on the budget and economy (Bob Richards, Grant Gibbons, Larry Burchall, Sir John Swan, etc. as well as blogs like VexedBermoothes.com, 21square.com, and newonion.com) have been attacked as being part of the “combined opposition” when we can now see that in fact they were prescient and correct.

Claim: Debt is neither good or bad, it’s how you use it that matters. A good use of debt is to re-invest at a higher rate of return than the cost of interest/repayments. The government has only done this with a small handful of projects that could have been financed purely from surpluses (had they banked the surprise excess revenue in the early/mid 2000s). The reality is that we got very little from our $1.45 billion and counting of debt and will face severe consequences of smaller sustainable government – 13% smaller (fewer jobs, fewer services) in the coming year and if the current trend continues we’ll be at over 20% of government’s income going to debt service within the next 5 years. Simple question: Has the $1.45 billion in debt been worth spending $105 million per year for 30 years to pay it off? For perspective, that’s roughly enough money to keep 2000 families out of poverty. I think the answer is self-evidently “no”. The current size of the debt alone sets the Bermuda government’s spending power back by about 10 years and decreases its long-term employing potential by about 1000 people.

Claim: The government was prudent in its financial management. This isn’t true because:
a. Budgets were routinely ignored. For the past several years the government has spent tens of millions of dollars a year more than budgeted.
b. There has been a pattern of financial mismanagement highlighted by the Auditor General for many years. As early as 2005 there were known to be huge financial issues in government with $800 million unaccounted for. Fast forward to today and the government is receiving qualified audits, and the Auditor General’s report is longer than the budget itself.

Claim: Bermuda still has a top financial rating. This is irrelevant because a) Bermuda will still face crippling debt service costs for the rest of our working lives, and b) rating agencies have been far behind the market in making downgrade calls. Spain, currently in a very public crisis over its debts and deficit only lost its AAA rating in 2010 and yet would probably have already lost access to credit markets and defaulted if the European Union had not committed to supporting it – so that’s 2 years from top rated to junk. For perspective – this year Spain and Bermuda will both spend about 13% of government revenue on debt service. When the ratings downgrades come they will come quickly and severely and ratings agencies have hinted that they expect to see a radical change of course after the election.

Claim: Debt to GDP is quite low. This is irrelevant because what matters is debt service cost. It doesn’t matter how much your house is worth if you can’t pay your mortgage – the same is true of Bermuda. It doesn’t matter how big our GDP is if we can’t pay our debt without hurting ourselves.

Claim: The UBP left infrastructure in bad shape so the PLP needed to increase spending to maintain it. This is not true because: Minister Michael Scott recently said that many government buildings are nearing the end of their lives. Bermuda buildings are stone and don’t have fixed lives unless they are not properly maintained. The jump in infrastructure spending would have happened in 1999-2004 if the PLP were actually making up for the prior government’s failure – the fact that the jumps in spending occurred years after the UBP left office suggest that it’s the other way around. The recent article about the Gibbs Hill Lighthouse is a very public reminder of this pattern.

Claim: The spending is stimulus. This isn’t true because the pattern of increased spending began years before the recession. If one graphs the budgets the spending line is a consistent straight line beginning many many years earlier. ┬áIt’s just that spending was increasing more quickly than revenue – the hallmark of classic financial mismanagement dating back almost a decade.

Claim: Keynes said we should deficit spend in a recession. This isn’t applicable because Bermuda does not meet the basic requirements for Keynesian stimulus. Keynes’ basic insight was that sometimes aggregate demand (total spending capacity of an economy) does not equal aggregate supply (total productive capacity of the economy) and that in times of a boom the government could cool the economy and prevent inflation by taking in money and saving it – in Bermuda’s case this would have taken the form of a sovereign wealth fund built up during the 2000s. Then in times when aggregate demand falls below potential the government can temporarily make up the gap by spending.
a. Bermuda is facing a permanent drop in productive potential.
Bermuda’s drop is permanent because it is driven by a permanent drop in population. This was caused by term limits and immigration as well as other anti-business policies. The government has been warned for years but ignored and attacked those who warned about the consequences in any public way. The constant stream of farcical and impractical policies like “Goodwill Plus” trotted out didn’t help things either.
b. Unemployment is largely structural.
There are jobs even in today’s Bermuda – with 8,000+ expats still on the island. The reason there’s unemployment is that the Bermudians’ skills do not match those jobs. That’s because the island has not systematically invested in its people beyond the age of 18. It continues to fail, with every investment being little more than a publicity stunt (like the recent drywall course where 11 of the 12 attendees were already employed).
c. Government cannot borrow at an interest rate lower than the rate of potential growth of the economy. Deficit spending only works when the deficit is financed at a lower rate of interest than the rate of growth that it causes. In effect when the government can borrow at 0% or 2% and create growth at 3% as the United States, for example, is able to do. Bermuda pays interest rates in the 5% range – and so is almost certainly destroying many tens/hundreds of millions of dollars of national wealth in the long-run.

No amount of “stimulus” spending will change these three.

Therefore the only stimulus that will work is removing the barriers that caused Bermuda’s population to decline – that’s Immigration and Term Limits.

To prevent a repeat, the government must re-invest tax revenues in Bermuda’s people on a large scale systematic way to address structural unemployment – this will need to include both character education and skills training. A side effect of addressing structural unemployment will be decreasing racial inequality.

“Stimulus” spending is a temporary political option that will help the ruling party in this election but hurt Bermuda for years to come. The only argument for continuing high spending that holds up is “but if we didn’t spend that much then we’d have to lay off 1,200 people”. Moving the layoffs until after an election is good politics, but for every year we wait to make those layoffs is another 150 jobs that will be permanently cut in the long-run due to the interest costs of waiting.

The big picture is that Bermuda is on its way to bankruptcy as a result of actions by politicians and the ultimate fallout will leave thousands unemployed.