Paul Martin Still Peddling The Same Fiscal Austerity Nonsense About Canada

Let’s be clear: we like Paul Martin and think his courageous stance against financial deregulation (which was the hot trend of the 1990s) was both far-sighted and prescient.  For that alone, he deserves to be a headline speaker at any global economic conference.

Unfortunately, our former PM and Finance Minister still dines out largely on the Canadian austerity experiment in the 1990s, and the Canadian experience under the Liberals in the 1990s is deemed to “prove” that one can experience “fiscal consolidation expansions”, as Canada allegedly did following the actions undertaken by the Liberal governments in the 1990s.  He was at it again last week at the annual Institute of New Economic Thinking (INET) conference in Berlin, which we had the good fortune to attend.  A closer examination of the period, however, suggests that whilst Mr. Martin’s narrative sounds good, in reality has no applicability for Europe today and introduces all sorts of fallacy of composition problems, since the EZ experience shows that everybody cutting means nobody grows.

First some history:  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 a number of policy makers in Europe to justify the continued ruinous fiscal austerity policies being pursued by the likes of Spain, Ireland, Portugal, Italy, etc. . 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. 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. 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.

And remember, Canada had a free-floating currency which could go down and thereby CUSHION the impact of the budget cuts (those cuts in and of themselves certainly did not “set the stage for recovery”, as many now argue).

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, it’s even harder for the EU countries, particularly those in the euro zone given global recessionary pressures and the corresponding inability to deploy an export-led growth strategy, given the existence of a currency union.. 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.

Not only is a Canadian-style fiscal assault proving to be a nonsensical short-run strategy, given the debt levels the euro zone private sector is carrying at present, but it is also not be a sustainable growth policy in the medium-term. Eventually, the private balance sheets become too fragile and households ultimately attempt to increase saving even further. This is what is happening today in Europe. Austerity is reducing aggregate demand further and income adjustments are forcing the public balance into an even larger deficit and set the deficit hawks toward cutting government spending with an even greater sense of urgency.

Mr. Martin. stick to a paean against financial deregulation.  You’re on much stronger ground there.  As fas fiscal austerity goes, 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?

One thought on “Paul Martin Still Peddling The Same Fiscal Austerity Nonsense About Canada

  1. You can talk anti-austerity all you want – the credit cycle is over. And there’s nothing you can do about it. Nobody will lend you money so you don’t have a choice but to be ‘austere’.

    The problems in the Euro are not derived from normal recessionary pressures – (thus any talk of Keynsian anything is moot) they are derived from the fact that EU countries were getting cheaper credit than they should have since the Euro integration. The current crises is a correction of those years of cheap debt – and magnified by the inflexibly of the Euro.

    Combined with the macro issues of the developing world sucking so many low-end jobs out of Europe – you have a serious, serious structural shift.

    Government spending will only exasperate the former problem, and do nothing to fix the latter problem.