Canada

10.07.12

David's Bookclub: Northern Light

Americans will do anything for Canada (or so goes an old saying) except read about it.

Which is always a shame, but never more than now, when Canada extends an example from which Americans could profitably learn. In the 1990s, Canada executed a dramatic fiscal turn-around. In 1994, observers wondered whether Canada might actually default on its debt. A decade later, Canada boasted the strongest balance sheet of any of the major democracies. As the world emerges from the 2008 financial crisis, Canada's record looks better still.

How did Canada do it?

That's a question that nobody is better positioned to answer than Brian Lee Crowley, head of Canada's Macdonald-Laurier Institute and an important outside outsider to the Canadian Ministry of Finance. In a new book coauthored with economic consultant Robert Murphy, Crowley offers both a description of the Canadian success and some gentle neighborly hints on a way forward for the United States.

The description is clear, lucid, and highly specific. But I worry something may get lost in the translation as the book is received south of the border. Crowley and Murphy take for granted some facts about Canadian life with which many Americans will be unfamiliar - and that American audience will benefit from some extra explication of their important book.

In two consecutive federal budgets, in 1995 and 1996, the Liberal government of Jean Chretien and his powerful finance minister Paul Martin cut spending by a cumulative total of 8.8%. Over two years, the size of the federal government dropped from 16.2% of GDP to 13.1%. Eventually, they would reduce the federal workforce by 45,000 persons, or 14%. By 1998, the Canadian federal budget had shifted into balance. Over the subsequent decade, Canadian federal governments (first Liberal, then Conservative) would run consistent budget surpluses to pay down the federal debt. Between 1994 and the eve of the financial crisis in 2008, federal debt as a share of GDP would be reduced from over 80% to under 50%. Canada slipped back into deficit during the financial crisis. It expects to return to surplus by 2015, and to continue reducing the debt burden to under 30% by 2017.

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By any measure, this is a stunning success story.

What lessons should Americans learn?

1) Canada relied mainly on spending cuts to reduce its deficits - mainly, but not entirely. Canada both cut spending and raised taxes, in a ratio of about 4.5 to 1. That ratio was rejected by every single one of the Republican candidates who sought the nomination in 2012, but if Americans are to make progress, they will have to get used to it. Crowley and Murphy do not say, but I would add, that the feasible American ratio would likely be tilted more to revenues than Canada's, because America today is a relatively low-tax country, which Canada in 1994 was not.

2) Canada was able to raise taxes without stifling economic growth in large part because of a decision taken by the Mulroney government of the 1980s: the introduction of a Value-Added Tax (called a Goods & Services Tax) in Canada. The VAT replaced an antique tax on manufactured goods, but it quickly raised much more money than the tax it replaced. Americans who dread a value-added tax because they fear that taxes only go up should know: the VAT rate has dropped from an original 7% to a present 5%.

3) Canada's ironic best ally in cutting spending was its single-payer healthcare system. The federal government was able to decree a reduced grant to provincial healthcare systems and thereby force the provinces in turn to cut healthcare spending in a way that would be much more difficult to execute within Medicare and Medicaid.

4) Integral to the success of Canada's budget-balancing was its acquiescence in a huge decline in the external value of the Canadian dollar, which dropped from 90 to the US $ in 1990 to a low of 63. A cheap dollar enabled an export boom that boosted Canadian-dollar-denominated GDP - and reduced the burdensomeness of Canadian-dollar-denominated debt.

5) As Canada's debt burden dropped, so too did its interest burden. Beginning in 2001, Canada was able to post both an increase in program spending relative to GDP and a decline in total spending relative to GDP thanks to the decline in interest payments.

6) In retrospect, the most amazing fact about Canada's fiscal turnaround was how politically uncontroversial it was. The actions of the Liberal government were broadly supported both by Canada's then-fractured Conservative opposition and accepted with only mild grumbling by the voting population. (The Chretien government won three successive majority governments in 1993, 1997 and 2001.) Provincial governments emulated federal policy, with an NDP (i.e., left-wing) government in Saskatchewan leading the way. This broad consensus made success both possible and enduring. It's a warning against the approach favored by many American Republicans, of hoping to win a huge mandate for one party and then imposing by main force a fiscal adjustment that wholly exempts Republican interest groups and loads all the costs of adjustment onto Democratic constituencies. This approach is unlikely to work, and even less likely to survive. For that sixth reason alone, Northern Light should be required reading for all American would-be budget balancers.