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Canada's former prime minister Jean Chrétien sat down with Reuters in his law offices to describe how his Liberal government eliminated the country's deficit in the 1990s. (BLAIR GABLE/BLAIR GABLE/REUTERS)
Canada's former prime minister Jean Chrétien sat down with Reuters in his law offices to describe how his Liberal government eliminated the country's deficit in the 1990s. (BLAIR GABLE/BLAIR GABLE/REUTERS)

The lesson from Canada on cutting deficits Add to ...

MacAulay, who represents the Prince Edward Island fishing community of Cardigan, has been re-elected six times and sits in the House of Commons today. He couldn’t be immediately reached for comment to recall the conversation.

RAISING THE ALARM

Canada’s scrape with disaster had been building for a long time.

Over a decade earlier, top Finance Department bureaucrats had begun raising the alarm about the problem of rising debt, a hangover from the big government era of the 1970s.

The period before Mr. Chrétien came to power in Canada is often likened to the situation in the U.S. today. The country was not yet peering over a precipice, but was fast approaching it.

Mr. Clark said he and his colleagues sent memos to their bosses in the 1980s explaining “the arithmetic”: growth was low, interest rates were high and it was only a matter of time before Ottawa would not be able to pay interest on its debt.

But successive governments ignored the warnings and wrote budgets that allowed spending to continue to grow.

“It was hugely frustrating,” Mr. Clark said. “Every year we put out forecasts showing the deficit going away. We just based every budget on ridiculous assumptions.”

The budget deficit more than doubled between 1980 and 1990, rising to 8 per cent of GDP in 1983 and 1984, before shrinking to a still unsustainable 5.6 per cent just before Mr. Chrétien took over, and all the time debt was soaring. The debt-to-GDP ratio shot up to 67 per cent in 1993-94 from 29 per cent in 1980.

The numbers aren’t that different to the U.S. today with its deficit of around 9 per cent for 2011, and debt-to-GDP ratio at 74 per cent, up from 40 per cent at the end of 2008.

Drawing a parallel to Washington, Mr. Clark said Canadian leaders before Mr. Chrétien paid lip service to the debt problem but did nothing.

“There are no lights blinking saying you’re at the edge of the cliff,” he said. “The one lesson others can give the U.S. is that the higher that debt-to-GDP ratio goes, the more difficult it’s going to be.”

Canada already faced a gaping current account deficit, a weakening currency and high interest rates, and more misery was inevitable if the debt crisis wasn’t addressed.

The first kick in the teeth from abroad came from the October, 1992, S&P downgrade.

Even two decades later, Don Drummond, in charge of the budget at the finance ministry at the time, bristles at the memory, saying that the downgrade should have been “completely irrelevant” because so little of Canada’s debt was in foreign currency. But the damage to public opinion was done.

“We were just mobbed by the media. Here’s some foreign institution that says Canada is a basket case. If we had had a Canadian agency downgrade us, probably nobody would have shown up,” Mr. Drummond said.

The politicians had ignored the bureaucrats, but there was no way to sweep international criticism under the rug.

“Fear drives people. It drove us,” Mr. Clark said.

‘THEY DON’T GET IT’

The Liberals thought their first, rushed budget – delivered in February, 1994, three months after taking office, was tough.

It reformed unemployment insurance entitlements, and cut defence and foreign aid, as well as closing some business tax loopholes and ending a $100,000 lifetime capital gains exemption. The savings totalled $10-billion over two years.

The government said it would review all programs and predicted a deficit of 3 per cent of GDP in 1996. But program spending was still budgeted to rise slightly, and the budget was widely seen as a failure.

Pete DeVries, who headed the fiscal policy division, remembers overhearing chatter from economists’ and others as he waited for a flight to Toronto just after the budget.

“The mood was so depressed on that plane that I thought we’re never going to get off the ground and if we did get off the ground we’d crash, because it was just doom and gloom,” he said. “Everywhere you heard the words, ‘They don’t get it. They just don’t get it.’ ”

Voters certainly didn’t get it. People who had cancelled vacations or taken a second job to make ends meet in the recession couldn’t understand why Ottawa thought it could live beyond its means.

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