When British Prime Minister David Cameron got serious about tackling the country’s debt problem in 2010, he looked to Canada’s experience two decades earlier for inspiration.
Among other things, he wondered what kinds of spending cuts would work, how deep should the chopping go and what would happen to unemployment?
Three years on it is now clear that austerity has not produced a Canadian-style recovery.
Instead, Britain’s list of troubles seems to grow daily. The country has just lost its coveted triple-A credit rating, leaving just Canada and Germany among major industrial nations with top credit scores from all three ratings agencies that make borrowing at discounted rates possible.
The British pound is tumbling. Inflation is worryingly high. The economy is at a near-standstill.
Austerity has caused deep pain and angered Britons, but it has not fixed the country’s debt woes. The country’s ratio of debt to gross domestic product is still climbing – from a projected share of 95.4 per cent this year to 98 per cent in 2014, according to a new forecast by the European Commission. Economists say relief from Britain’s debt hangover may have to wait until 2015-16.
Deficits are higher now than when Mr. Cameron’s austerity coalition began its work in 2010.
Why the Canadian austerity model failed
“If you went back and tried to figure out what Britain did wrong, some of them were just given [rather than self-inflicted],” said Mark Chandler, head of fixed income strategy at RBC Dominion Securities.
Canadians can thank some good old-fashioned luck for what happened in the 1990s. Canada’s financial turnaround two decades ago was a combination of policy and happenstance. The tech boom was just starting and the U.S. economy roared ahead, lifting Canada with it. The dollar weakened, exports surged and the stock market went on a tear.
“Using Canada as a model would have put the U.K. in good stead if they had got the same kind of benefits that Canada did,” Mr. Chandler explained. “But they didn’t.”
Britain, meanwhile, is getting no help from its neighbours. The economy of continental Europe is expected to shrink this year, making it tough for Britain to export its way out of trouble.
And until the British pound began its recent free fall, exports were getting no help from a competitive currency.
A debt addict’s confession
Last week, Moody’s, the big credit rating agency, added insult to injury, stripping Britain of its top credit rating – a move that can make borrowing more expensive and hamper efforts to reduce debt. Ratings are a measure of the risk attached to lending money to a target country – the lower the rating, the higher the borrowing costs (all else being equal).
Like an alcoholic at an AA meeting, the debt downgrade prompted George Osborne, Britain’s Chancellor of the Exchequer, to concede the country has a problem.
“The single most important truth about our economy,” Mr. Osborne acknowledged, is that “Britain has a debt problem, built up over many years, and we have got to deal with it.”
Where did Britain go wrong?
The admission is welcome. But some critics say Mr. Cameron, Mr. Osborne and Bank of England Governor Mervyn King have a lot more to fess up to, including years of botched policies.
In a scathing opinion piece in the Financial Times last week, Institute for International Economics president Adam Posen said the government is blindly perpetuating the policy mistakes of the 17-member euro zone.
“It is time for the U.K. government to take a good look in the mirror and see that its policies are now following the very European patterns it mocks,” argued Mr. Posen, who served for three years as an external member of the Bank of England’s rate-setting Monetary Policy Committee until last fall.
“It is not merely somewhat embarrassing. These policies are in large part to blame for Britain’s failure to recover from the financial crisis.”
Mr. Posen faults Britain for pursuing austerity too fast, while doing little to spur investment. British authorities, he argued, have also been too lenient on banks, letting them delay writing off loans and doing little to promote more competition. And Mr. Osborne said unconventional monetary policy hasn’t yet worked in spurring borrowing by consumers and businesses.
Analysts are not hopeful a quick fix is in store for Britain. An economic recovery felt by average Britons may still be years away.
“Britain’s economy has been stagnant for the past couple of years,” said Andrew Grantham, economist at CIBC World Markets Inc. “That’s not going to change soon.”
The temporary lift from last year’s Olympic Summer Games in London obscured the country’s deeper predicament.
Britain is at least two years from starting to relieve the weight of its debt burden. Inflation, now running at 3 per cent a year and well above the Bank of England’s target, is likely to remain high for the simple reason that British prices are generally lower than they are elsewhere in Europe.
Credit conditions remain challenging. The Bank of England’s Funding for Lending program, which allows banks to borrow at discounted rates, seems to have helped the housing sector. But business borrowing remains sluggish.
And once again, Britain is looking to Canada for help. Mark Carney is set to take over as governor of the Bank of England on Canada Day.
Britain wants him, Mr. Carney explained recently, because he is an outsider with fresh ideas on getting the economies of Britain and Europe going again and fixing their troubled financial systems.
And this time they are hoping the Canadian touch works.