(2)  Fiscal constraints weigh on supply of public capital

In addition to growth pressures, weak fiscal positions have been a major culprit in holding back government investment in infrastructure over the past few decades. Although Canada's federal government began to run deficits in the 1970s, it was not until the 1980s that the provinces would start to encounter significant budgetary problems. By the early 1990s, the combined shortfall at the federal and provincial level (i.e., local governments are not permitted to run deficits) had swelled to a whopping $65 billion, or 9 per cent of GDP. Facing a dire predicament, the federal and provincial governments then began to wage war on their deficits, although the fiscal turnaround would take the better part of five years.

During the period of rising deficits in the 1980s, and especially in the era of restraint in the 1990s, the federal and provincial governments found it more politically palatable to pare back spending on capital rather than operations for a number of reasons. First, the impact of capital cuts was less noticeable than operating cuts in the short run. Second, governments accounted for the purchase of capital projects on a cash-basis, which is a method whereby the full cost of the asset is booked in the same year the cash left the door, rather than gradually over its useful life (i.e., accrual method). As a result, immediate and significant savings could be achieved by slashing capital expenditures. And, lastly, the development of new infrastructure tends to be accompanied by higher operating costs, as additional staff would have to be hired, et cetera. Thus, cost reductions from reducing capital spending also extend to the operating side.