Britain’s Deficit is a Lesson For Canada

In the summer of 2010, the UK embarked on a strange economic experiment.

Britain, then in the grip of a post-crash recession, had just elected a new government led by the Conservative party. In his first budget, the Tory finance minister, George Osborne, reeled-off a litany of cuts: public sector pay would be frozen, pensions reformed, disability and housing benefits slashed, and a raft of progressive tax credits abolished. In total, more than £30bn ($50bn CAD) would be stripped from state expenditure every year until 2015.

The purpose of all this pain, Osborne explained, was to eliminate Britain’s deficit: Britain had borrowed too much during the boom years and now risked plunging into a ‘sovereign debt crisis’ of the sort that had recently struck other European countries, notably Greece and Spain.

But there was a problem. Osborne’s strategy ran counter to one of the basic lessons of modern economic history: you don’t reduce spending in the face of a downturn — you increase it in order to stimulate growth.

The Tories, however, were implacable. Despite repeated warnings from economists (even the IMF got in on the act), they kept on cutting, almost without pause. And the results, predictably, were disastrous. By the time Osborne left office in the wake of the 2016 Brexit vote, Britain was a wreck: wages had slumped, growth had stalled, productivity was chronically deflated, and hundreds of thousands of people had been jolted into poverty.

Britain’s experience stands as a stark example of what happens when politicians become obsessed with expiating visions of ‘fiscal discipline.’ Thankfully, that’s not (quite) where we’re at in Canada right now. But there are some ominous signs on the horizon as the 2019 federal election rears into view.

According to research from the Angus Reid Institute, Canadian voters now rank “government spending and the deficit” as the main challenges facing the country - and they believe Andrew Scheer is better equipped to manage the economy than Justin Trudeau.

Scheer's position on the deficit is clear. Responding to the federal budget back in February, the Conservative leader denounced the Liberals’ “out-of-control spending” and noted that “the deficit for this fiscal year is $18 billion, which is triple what Trudeau promised during the 2015 election.”

This is both technically correct and subtly misleading. Yes, Trudeau has spent more than he said he would and, yes, the federal deficit will hit $18 billion by the end of 2018. But $18 billion represents less than one percent of Canadian GDP. And, on current growth trends, the deficit is due to fall - to 0.5 percent of GDP - by 2022.

These numbers are minuscule by international standards. For context, America’s budget deficit is 4.2 percent of GDP, France’s is 2.6 percent, Italy’s is 1.7 percent, and Japan’s is 4.4 percent. In fact, Canada has the third smallest deficit and the smallest debt-to-GDP ratio of any G7 country. So it’s not credible to argue that Ottawa is in the middle of an unsustainable spending binge.

But fiscal hawks only ever see government ‘profligacy’ as a threat. They are oblivious to the market’s capacity for collapse.

Britain and Canada have something else in common in this respect.

Both countries currently face rapidly over-heating housing markets and dangerously high rates of household debt. In Britain’s case, the prospect of another crash is amplified by a poorly regulated and disproportionately large financial industry. In Canada’s, credit-fuelled consumer spending in the property sector puts the stability of the banking system at risk.

And yet, neither of these looming crises features prominently — or prominently enough — in mainstream debates about the economy. Instead, commentators fixate on government spending as the sole metric of economic success. (For the record, both Ireland and Spain maintained exemplary national balance sheets in the years leading up to the Eurozone crash.)

Above all, endless agonising over the deficit almost always leads to the same place: deep cuts to public expenditure.

After the financial crisis, the British Conservatives moved quickly to frame the UK’s mushrooming national debt as a consequence of excessive spending under successive Labour administrations. In reality, Britain’s debt rose because growth and tax revenues plummeted, unemployment increased, and the government spent billions bailing out the banking sector.

The Tories’ PR offensive against left-wing “deficit deniers” was so effective, however, that Labour buckled under the emerging austerity consensus. In 2013, George Osborne - aided by a weak opposition and compliant media class - felt confident enough to reveal his end game: cutbacks so far reaching they would reduce Britain’s public spending ratio to levels not seen since the 1930s.

Ironically, some of the ideological groundwork for Osborne’s plan to carve-up the UK welfare state was laid here, in Canada.

In 1994, Paul Martin, then the Liberal finance minister, unveiled a package of cuts centred around unemployment support and provincial funding. “For years, governments have been promising more than they can deliver, and delivering more than they can afford. That has to end,” he said. Martin went on to squeeze federal expenditure by over five percent of GDP by the turn of the millennium.

Martin’s notion of “expansionary austerity” — the idea that shrinking the size of the state will generate swift private sector growth — was picked up two decades later by Osborne, who repackaged it in his own (artless) terms as “expansionary fiscal contraction.”

Obviously, neither “expansionary austerity” nor “expansionary fiscal contraction” worked. In recent decades, Canada’s economic growth has owed infinitely more to resource booms, strong exports, and asset inflation than it has to limited government. And, of course, Osborne’s decision to use Britain as a testing ground for his inchoate libertarian fantasies remains a spectacular ongoing mess.

Bear that in mind the next time you hear a politician — on either side of the Atlantic — roar into hysterics over the deficit.