One of the saddest outcomes of the recent federal election was the destruction of the reigning all-party consensus in favour of balanced budgets and spending discipline outside times of economic crisis. The greatest irony is that it is the Liberals, who forged that consensus, who signed its death warrant. Having promised to borrow tens of billions of dollars over the next several years, they have an undeniable mandate to pursue this policy. That does not make it a good idea.
Defenders of the borrowing to fund infrastructure spending make the case that Canada has suffered from austerity that has depressed economic activity. Moreover they say that the deficits are small relative to the economy (which is true), so it doesn't really endanger Canada's finances. They are so small in fact that Canada's debt-to-GDP ratio will continue to fall despite the renewed borrowing.
Both of these arguments are exceedingly weak.
Take the argument that government austerity causes a slowdown in economic growth. One might be able to make that case in theory, but one of the Chrétien Liberals' proudest policy legacies was disproving it in spades in practice.
Paul Martin's 1995 budget proposed cutting billions in spending while reducing federal government employment by almost a sixth.
The absolute dollar amount of Ottawa's total spending fell by more than 7 per cent from 1995 to 1997, while program spending (excluding interest) fell by almost 10 per cent. As a share of the economy, federal spending fell from almost 22 per cent to 19 per cent during the same two-year period. From January, 1995, through January, 1998, federal employment plunged by 51,000 – a drop of 14 per cent.
The federal government ran 11 consecutive budget surpluses beginning in 1997-98. Total public debt plummeted from 80.5 per cent of GDP to 45 per cent within a decade.
On the new government's argument, this should have produced a massive slowdown in the economy. Instead, over the decade of the Martin reforms, Canada led the G7 in job creation, inward investment and economic growth while nearly halving poverty rates.
It has become fashionable in some circles to try to belittle this achievement by suggesting the government was just lucky and that the country's economic turnaround was not due to fiscal discipline, but rather some combination of rising oil prices, a falling dollar and declining interest rates. But if you actually look at the data (something every good Liberal now treats as the defining difference between them and the Tories), none of these explanations is correct.
Take oil prices. During the crucial period from 1994 to 1998, when the budget deficit moved from 4.8 per cent of GDP to a surplus of 0.3 per cent of GDP, nominal U.S. oil prices fell from $15.53 to $13.26. During the same period, the exchange rate was virtually flat. And there are plenty of other periods in recent history where movements of the Canadian dollar contradicted the theory that a falling dollar improved public finances. Interest rates did make some modest contribution to helping Canada balance its budget, but let's get this in perspective. In 1995, Ottawa paid $46.3-billion in interest, while the deficit was $32.1-billion. Two years later, debt charges had fallen by $2.9-billion while the deficit had become a surplus of $2.5-billion – a swing of $34.6-billion.
In other words, governments restraining their fiscal appetite have a good track record, and this is supported by authoritative independent observers like the European Central Bank: "case studies conducted for Belgium, Ireland, Spain, the Netherlands and Finland found that fiscal consolidations based on expenditure reforms were the most likely to promote output growth, especially when combined with structural reforms. Overall, it appears that expenditure-based fiscal consolidations are more successful and have more beneficial effects on long-run economic growth than revenue-based ones."
As for the idea that the proposed deficits are too small to matter, this too flies in the face of Canada's postwar experience. The issue is not the size of the deficit in any one year but the dynamics that deficit financing unleash.
The mess Paul Martin had to clean up was caused by a loss of fiscal discipline that began years earlier in 1974, when a long unbroken string of federal deficits began. Nobody in 1974 argued that they were going to destroy public finances for a generation. Each year's finances were looked at on their merits. It was just that once the deficit-financed spending taps had been opened, it proved politically impossible to close them again.
Why? Because every spending program creates a constituency that has an interest in seeing the spending continue, while deficits allow politicians to engage in the magical behaviour of rewarding these voracious special interests without having to raise taxes on everybody else. At least until the bill finally comes due, which it inevitably must.