The United Kingdom Draws the Wrong Lessons from Canada
by Roosevelt Institute Senior Fellow and Braintruster Marshall Auerback at the New Deal 2.0
For once, Canada is making the news for the wrong reasons. The United Kingdom has braced the country for cuts in government spending up to 20 percent as the new Conservative-Liberal Democrat coalition lays the groundwork for an austerity program to last the whole parliament. Their inspiration? According to The Telegraph, Prime Minister David Cameron’s administration hopes to draw lessons from the experiences of the Canadian Government of the 1990s. Before too much damage is done, we suggest they’d better re-read the history books a bit more closely.
The standard narrative of the Canadian experience in the 1990s is this: in 1993, Canada’s budget deficit and debt-to-GDP ratios were the second highest amongst the G7 countries, after Italy’s, and the US financial press was unfavorably comparing Canada to Mexico. That year, with the IMF supposedly lurking at the door, the Liberal Government of Prime Minister Jean Chretien, and his Finance Minister, Paul Martin, laid out a goal to halve the budget deficit to three percent by 1998, with an unannounced goal of a zero deficit by 2000. Martin began cutting costs significantly in 1994, chopping 10 percent from department budgets and converting a deficit equal to nearly 7 percent of gross domestic product into a surplus by 1997. By 1998, the deficit was eliminated and overall debt was dropping quickly, amidst a rapidly growing economy.
Success, correct? Certainly, this narrative has largely gone unchallenged (even in Canada). It has metamorphosed into received wisdom and has been used by many to justify a renewed assault on the welfare state. It is argued that the impact of Chretien government’s cuts in public spending allowed Canada to get through the Asian crisis with little damage and to go on to become one of the strongest Western economies.
And this is the lesson drawn by the British government. Hence, the remarks of the Chancellor of the Exchequer, George Osborne, who yesterday announced an unprecedented four-year spending review. According to Osborne, every Cabinet minister will have to justify, in front of a panel of colleagues, every pound they spend. He said the task ahead represented “the great national challenge of our generation” and that after years of waste, debt and irresponsibility it was time to bring public spending under control, guided by the principle that people should ask “what needs to be done by government and what we can afford to do”.
The Canadian experience certainly makes for an interesting story, although we suspect that the IMF threat was significantly overstated. In 1995, Canada had a debt to GDP ratio that was around half of that of Italy and Belgium. Yet curiously, those countries were never deemed to be ready-made victims for the Fund’s Little Shop of Horrors, even as Canada was supposedly threatened with the prospect of becoming a ward of the IMF a la the United Kingdom in 1976. In truth, the IMF threat represented yet another in a series of manufactured crises that enabled longstanding opponents of government spending to muscle through budget cuts in vital and politically popular social programs.
The reality is somewhat more complex, as Professor Mario Seccareccia of the University of Ottawa has noted in a paper entitled, Whose Canada? Continental Integration, Fortress North America, and the Corporate Agenda (pp. 234-58). In the paper, Seccareccia noted the real reasons for the “success” of the Chretien/Martin austerity programs:
1. High growth in the US, Canada’s largest trading partner, a sharply declining Canadian dollar (which fell as low as .62 cents against the greenback), and the implementation of the North American Free Trade Agreement (NAFTA), all of which combined to push the export sector’s share of Canadian GDP to 45% by 2000 (now about 33%), and
2. An expansionary monetary policy which did significantly stimulate consumer spending, and which was sustained until the financial crisis.
The turnaround emerged despite the fact that investment remained weak relative to historic economic recoveries. But the massive turn in the country’s external sector was largely made possible through a revival of growth in the US (Canada’s largest trading partner). The stock market boom in the US, the high tech bubble, and the beginnings of the American real estate boom created huge demand for Canadian exports, which largely drove Canada’s recovery. (All of which were fueled by huge increases in US private debt growth, another malign effect of the Clinton budget surpluses.) If anything, this vast improvement in Canada’s external account largely offset the deflationary impact of the fiscal austerity which, in any case, likely impeded, rather than facilitated, economic recovery, given the slashing of employment insurance and social welfare benefits.
The other byproduct of this Canadian “budget miracle” was the increasing indebtedness of the Canadian private sector, a phenomenon mirrored in the US by the Clinton Administration, which repeatedly recorded budget surpluses in the late 1990s. Again, this is no surprise to those of us who adopt the financial balances approach, but it does give a fuller (and less flattering) picture of the ultimate impacts of eliminating Canadian “fiscal profligacy”.
The chart above highlights the importance of Canada’s restrictive fiscal policy in pushing the household sector balances increasingly into the red until the financial crisis of 2008 (also accompanied by a massive increase in the Canadian budget deficit, which almost certainly cushioned the impact of the crisis in Canada).
In any event, Canada’s export boom of the 1990s is a miracle that could certainly not be repeated today, given the decline in global economic growth, and the extent to which the ailing manufacturing exports sector is now being hammered by the so-called “Dutch disease” as a consequence of the Canadian dollar’s relative strength.
By the same token, the United Kingdom would hardly do any better today, given global recessionary pressures and the corresponding implosion of its largest export markets in Europe and the US. If Prime Minister David Cameron is indeed preparing Britons for a Canadian-style attack on the deficit, he is acting on the basis of profoundly misguided historical information. Canada’s growth was largely stock market bubble-driven, so both the US budget surpluses and the Canadian miracle were based on a one-off fluke. From the sector balances approach, we know that unless you get something like one of the biggest bubbles of all time in your own economy or in a major trading partner’s, don’t count on recovery in the face of fiscal retrenchment. The UK government’s current monomaniacal fixation on deficits and its simplistic reading of Canadian history will do nothing more than cut back on vital stimulus that has cushioned the UK from a far greater disaster, all to satisfy the loons in the conservative press and some threatening types in ratings agencies . Not only would a Canadian-style fiscal assault be a nonsensical short-run strategy, given the debt levels the UK private sector is carrying at present, it would not be a sustainable growth policy in the medium-term. Eventually, the private balance sheets would become too fragile and households would attempt to increase saving even further. This would reduce aggregate demand further and income adjustments would force the public balance into an even larger deficit and set the deficit hawks toward cutting government spending with an even greater sense of urgency. The Canadian experience teaches us very little. There is never a case for fiscal austerity in periods of cyclical weakness unless you can recreate the conditions of a financial bubble. But aren’t we paying the price for that today?
Posted with author’s permission from the New Deal 2.0.
The UK is a large economy, with well-established political parties. Those parties have their own agenda’s, and are well-staffed with policy experts who argue for various versions of agenda items. Given that budget austerity is in line with traditional Tory goals, and that this is a coalition containing the Tories, it seems to me that Canada is just a nice story. Such nice stories are their to comfort people who are worried that some change or other will do them harm, but who are willing to be convinced otherwise.The reality of Canada’s circumstances probably aren’t a central issue for the new government’s story tellers.
Not wild about this version of the Dutch Disease, by the way. The link argues for little more than the impact of currency fluctuations on trade. When the Dutch went through the Dutch Disease, very high rates of return in the resource sector drew the best workers from other sectors, so that instead of fostering general growth, the resource boom skewed the economy toward one sector. Currencies go up and down all the time. The Netherlands’ problem was more complicated than that, and not one that Canada has suffered merely because the C$ has firmed up. Canada, to my knowledge, does not suffer a shortage of highly trained workers in the majority of sectors because they have all been drawn to high wages in a single, lucky sector.
yes, but i kind of think they know that. the deficits are a trumped up problem so the “conservatives” can get control and do things the way they have always wanted. they are not so much interested in the welfare of the country as in their own private welfare.
remember that Reagan’s budget director explained all so long ago was that the object was to spend the country into a condition where it could no longer afford social programs.
Canada’s success during the 1990’s may have been on the coat tails of a US economic boom but it used the growth period to get rid of debt. Canada did not suffer as much in the current recession because banks are regulated so no banks failed and the toxic mortgages were not permitted by regulation. It is folly for Britian to cut spending during a recession. Are they hoping for a depression? Canada has many social programs which keep huge numbers of people employed and paying taxes so there is stimulous money for the government to help the economy.
I completely agree with kharris. That was almost exactly what I was going to say. Austerity was a pre-existing goal of the ruling party and the voters who voted for them. They are not taking any “lessons” from Canada. They are doing what they always wanted to do and then searching the annals of history for support.
“Trumped Up Deficits by Conservatives”…….
Lay off the sauce dude! Try placing a cool cloth over your eyes, put your feet up, take two asprin, and call me in the morning.
Good Night Sweetheart!
thanks jimi
i have often wondered what it would be like to be back in grade school knowing what i know now.
jones
i agree about the ruling party, but i don’t think the voters who voted for them have a clue. they think they are cutting their taxes and reducing the “burden” of government” and, of course, saving themselves and their children from a horrible debt ™.
“There is time to every purpose under heaven” Ecclesiates — slightly modified by Pete Seeger.
There is certainly a time for austerity — generally when conservatives think everything is going fine and it’s time for tax cuts and maybe a little imperialism. But this is not one of those times. Not in the US. Not in the UK. Probably not anywhere. However, it’s not clear to me why I should worry about British self-immolation. If they want to hurt themselves, who am I to say they shouldn’t.
Codger
because what they are doing is part of a world wide conspiracy.
if you don’t like the word “conspiracy” call it something else. but political interests have always organized to get what they want, and it is beginning to look as if the bond interests have finally got the organization they need to get rid of this damn new deal nonsense.
there is a worldwide assault on retirement. it doesn’t make any sense except from the point of view of those who think that workers are for working. why would workers want to retire anyway? and if you let them pay for it in a secure way… through some government program… why, that’s exactly what they will do: pay for their own retirement and then retire and do something else besides make money for the boss. can’t have that, you know. pretty soon they’ll be forgetting to doff their caps.
We’ve all seen the progression. Bush wanted one last tax cut, but that was all he’d do when recession loomed. He mostly left to to Obama to deal with passing a stimulus package, which meant delaying and allowing the recession to get worse. Then, it was “not too close to a trillion dollar price tag, please”. Then it turned out the labor market was tons worse than expected, and it was “check back in the autumn, when we have a better feel for what’s going on.” ‘Bout that time, Krugman started saying “1937? Anybody remember 1937? Say it with me – don’t repeat 1937…” Romer and Summers and Geithner all said “we hate 1937”. Bernanke isn’t wild about 1937. But there is still all that foot-dragging that makes no economic sense.
But Germany has forgotten (which is really a wild notion) and the UK has forgotten (hey, there’s a pattern here). The OECD/IMF/ABCDEFG have forgotten. Germany and the UK are in the hands (at least partly) of rightwing parties (which are just to the left of US Democrats in most ways), which helps to explain it. The US just isn’t in the same class as the UK and Germany. DLC politics and a deep-seated realization that the GOP is just better at making the public believe nonsense are the only excuses that US Democrats have.
Krugman has a brief post on this today, and emphasises with a nice graph what everyone seems to be glosssing over – that Canada had a substantial currency devaluation relative to is major trading partner – which would be he U.S.
Interestingly, this Canadian experience is one of Sumner’s “neolibeal economic success stories” from a few weeks back. I guess he just forgot about the devaluation.
Coincidentally, Canada, at that time not against the 0 interest bound, was also able to loosen monetary policy. I never realized that was part of the neoliberal economic agenda.
Anyway, Krugaman’s point is when you look at historical precident, look at the whole picture, with context, and don’t cherry pick the aspects of it that fit your preconcieved notions.
Cheers!
JzB