I came across a highly interesting column concerning early 1990s Canada, who which saw their debt to GDP ratio skyrocket, slow growth stemming from high interest rates, and downgrades by the major credit rating agencies. Canada's welfare state grew under Prime Ministers William Lyon Mackenzie King, Lester Pearson, Pierre Trudeau, and Brian Mulroney, but reached a point that by the 1980s, fiscal issues stemming from the expansive social programs along with the slowing growth were looming and would eventually explode heading into the 1990s. Further exacerbating this issue was the weakness of the Canadian dollar.
After a Liberal Party budget released in 1994 to widespread criticism for the fact that it still included spending increases despite the numerous reforms that were included in the budget package, Chretien, then Finance Minister Paul Martin, and the rest of the Liberal Party broke out the scissors, shears, axes, chainsaws -- whatever adjective that describes cutting that you want to use -- and took to reducing Canada's debt.
Canada's debt-to-GDP ratio reached its all time peak in 1995-96 in the midst of the implements of the cuts. Growth actually did stagnate, according to a CBIC study, whenever Martin called for widespread spending freezes in 1996. Chretien would push for departments to cut budgets -- which ranged from as little as 5% to as much as 65%. In addition, the ratio of spending cuts to revenue increases were 7 to 1, as Chretien would note in his interview with Reuters it was about "what was needed most." The spending cuts did have adverse effects as Canada's Medicare system suffered budget cuts that lengthened medical waiting lists (which is what you hear of constantly when United States conservatives deride the Canadian healthcare system) and put many provinces in a serious bind as they depended on the federal government for funding of some services.
The final component of the turnaround came when the Bank of Canada lowered interest rates in 1996, allowing Canada to finally reap the benefits of the fairly positive global economy, spurred by the United States and China's economic growth. Canada's budget returned to black ink in 1997 and remained so until the global financial crash and North American auto industry crash of 2008 and 2009. There's also the fundamental difference between the Canadian outcome from the recession as opposed to the outcome in the United States -- Canada emerged from it a year later as the most fiscally healthy country of all the G7 nations.
There are two key things about the success of Canada -- for one, the Canadian government scaled back to a more manageable proportion of size and role versus population it is supposed to serve. Let's not get confused here -- Canadian social programs are held to high regard and are fairly popular in Canada, even though some of the Canadians I spoke to complain about the Goods and Service Tax. In addition, and probably the most important thing, is that the Canadian government was largely united in tackling the deficit.
However, here in the present-day United States, we're treated to ideological warfare between a left that is sick of concessions and a right that is exercising reactionary power play. Austrian economists such as presidential candidate Ron Paul (R-TX) argue for spending cuts, tax cuts, and reduced government while Keynesian economists such as Nobel laureate professor and New York Times columnist Paul Krugman that argue against draconian cuts because of the harm they would do to the economy. I cite Paul as an example because Paul has demonstrated to be the only person on the Republican side that truly has an understanding of economic theory. I cite Krugman, not because of him being a Nobel Prize winner in economics, but because he is the largest trumpeter for the mixed economy.
The Canadian government's austerity push in the mid-1990s proved both of them to be right. As stated before, spending freeze mandates and tax cuts actually stagnated Canadian economic growth (proving Krugman right), while at the same time allowed the Canadian government to become leaner and more efficient (proving Paul right). However, the fundamental difference was how instrumental the central bank was in Canada's recovery -- something that would be to the chagrin of Paul, but not exactly -- the Bank of Canada decided to finally rectify years of poor monetary policy by reducing interest rates. The Federal Reserve's monetary policy is pointless -- low interest rates really only work when banks see credit extension as an asset and not a liability.
The true value of Canada's turnaround is not necessarily about luck; its about how political leaders put aside ideology for the greater good of a nation in recognition of what needed to be done. The Liberal Party cutting spending is similar to the Republican Party reversing Bush era tax cuts, but as much as the Liberal Party hated to do it (as then Finance Minister Paul Martin once disclosed), the Party had to set aside its ideological platform of social welfare expansion for the greater good of Canada. The Liberal Party actually demonstrated that neither political party has been able to demonstrate down here -- putting aside a staunch ideology stance to bring needed stability to the country instead of only having a narrow minded view through the eyeglasses of their beliefs as to how to achieve it. The greatest failure, in my opinion, of Washington these days is that a political party's need to triumph in political chess is outweighing getting anything done -- especially in the case of the Republican Party.
There was an additional footnote that Chretien and others noted that politicians can still win elections despite massive austerity measures. However, one thing that kept Chretien in power for 10 years as Prime Minister was the growth of the Canadian economy in the late 90s to the early 2000s. If people can see a beneficial payoff of a given administration, then people will keep that administration in power. People saw the payoff in keeping Ronald Reagan in power in 1984, Bill Clinton in 1996, and George W. Bush in 2004.
So what is the greatest lesson that can be learned from the Canadian austerity model of the 1990s? Its not the spending cuts and tax cuts and those said cuts exceeding, by proportion, increased taxation. The reason why the measures taken by the Liberal Party of the mid-1990s worked for Canada is because Canada provided a welfare state that was way too big for a population to be able to pay for and had an economical system that allowed for the federal government to carry too much weight in the mixed economy balance. The issue in the United States is less about the welfare state and more about entitlement spending and an eroding tax base augmented by a complicated tax code that actually does more bad than good to the fiscal health of the United States. The biggest lesson learned is that the controlling Liberal Party set aside ideology to solve a problem. The United States government needs to solve problems first and worry about how that problem solving abides to ideology second (preferably, not really worry about it at all). A continued failure to do that will only exacerbate problems and quite possibly lead the United States to that "decline" from the perch of secured supremacy in an insecure world.
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