For obvious reasons, the fiscal affairs branch of the International Monetary Fund is a tad busy these days.
These are the folks who perform the analytical and intellectual grunt work that will inform managing director Christine Lagarde’s attempts to persuade the Group of Seven nations to get a handle on their debts. And they like what they see in Canada’s recent history.
In “Chipping Away at Public Debt: Sources of Failure and Keys to Success in Fiscal Adjustment,” a compilation of studies of the G7 countries by IMF economists edited by Paolo Mauro, Canada emerges as a beacon for what it takes to get out of a fiscal mess.
Old news, right? If you accepted at face value the myth building of Jean Chrétien and his Liberal ministers about their heroics in the mid-1990s, yes. If you always wondered if the Liberals were giving themselves too much credit, then the “Chipping Away” analysis suggests you were too cynical.
The most important thing Mr. Chrétien and his finance minister, Paul Martin, did was establish public support for austerity. When the previous Progressive Conservative government took a run at reducing the budget deficit in the mid-1980s, polls showed support of spending cuts was almost non-existent. By the early 1990s, surveys showed that 70 per cent of the population ranked the deficit and debt as the priority. The Liberals capitalized on this high level of awareness by going to the public well before their first budget in 1994 to brace people for the tough choices that were coming.
The other thing that the Liberals did right, according to the IMF analysis, was come up with an ambitious program with specific changes to the way government operated. This was the failing of the Conservative attempt at budget cutting a decade earlier. The government of Brian Mulroney made broad, across-the-board cuts that failed to convince financial markets that policy makers were committed to the task.
The Conservatives actually closed the deficit more than they said they would, exceeding their initial projections by an amount equal to 0.3 per cent of gross domestic product. But the Liberals exceeded their forecast by 1.7 per cent of GDP, according to an analysis by the IMF’s Cemile Sancak, Lucy Qian Liu and Taisuke Nakata. Mr. Martin achieved this in large part by making important structural reforms, such as changes to unemployment insurance and a reduction in transfer payments to the provinces.
It is important to separate Canada’s -- and everyone else’s – austerity program from economic growth. The analysis in “Chipping Away” is about what it takes to get an oppressive debt burden under control. (Canada’s net debt was 73 per cent of GDP in 1993.) The book makes no attempt to draw a link between the improvement in Canada’s fiscal position and the economic boom that followed.
However, a sober, analytic look at Canada’s experience with fiscal crises helps explain why so many countries currently are struggling. There is not as of yet broad public acceptance of austerity in the United States and many European countries, nor have their governments laid out bold, coherent plans and stuck with them. Just think of how many times Greece and Italy have revised their fiscal plans in recent weeks, not to mention the agony the U.S. went through over the debt ceiling.
When it comes to budget crunches, politicians everywhere too often look for the easiest way out. In a separate article in the IMF’s Finance and Development magazine, Ms. Sancak and Jiri Jonas compare the Chrétien government’s budget consolidation effort with that of the Clinton administration. It seems forever ago now, but the U.S. ran a budget surplus during 1998-2001. Both Canada and the U.S. achieved fiscal consolidations equal to 5 per cent of GDP. But the U.S.’s efforts didn’t hold. The IMF economists’ conclude that’s because the Americans cheated, letting the economic boom do too much of the work for them. Canada made structural reforms and they have held.
Canada’s lesson to the world might be political courage. “Actual implementation was not weakened by greater ambition: higher planned adjustment was associated with higher actual adjustment, one-for-one, on average,” Mr. Mauro concludes in “Chipping Away.” “This evidence suggests that it is `okay to plan big,’ because ambitious plans do tend to produce more adjustment tan do more modest ones.”
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