PAUL MARTIN: THE IDOL OF FISCAL CONSERVATIVES
Recently Brian Crowley published two articles in the Globe and Mail arguing that deficits “don’t promote economic growth” and “stimulus proponents disregard dangers of deficits at their peril”. Fortunately, in the last election, the majority of Canadians didn’t agree with him. They elected a government that is prepared to invest in the future and run deficits.
What is particularly strange is that Mr. Crowley’s argues that Paul Martin’s 1995 austerity ”budget”, on its own, actually led to the subsequent recovery in economic growth in Canada and the resulting budget surpluses. Let’s be clear, no one who (including ourselves) was involved in the planning and implementation of the 1995 budget, thought that the only thing necessary was cutting the size of government.
It is certainly the case that Mr. Martin had no choice but to implement a major and unprecedented reduction in program spending. Canada’s debt-to-GDP ratio was approaching 70%, the second highest among the G-7 countries. The government faced a fiscal crisis and a credibility crisis. The 1995 budget was partially responsible for eliminating both crises. But a lot more was needed to make fiscal consolidation a successful solution to the problem.
Contrary to Crowley, the mid1990s was one of those very rare periods where a lot of positive factors came together at the same to help resolve the 1995 “fiscal crisis” and create strong economic growth: expenditure restraint, partial de-indexation of the tax system, and reforms of the personal, corporate and sales tax systems introduced by the previous Conservative government that led an operating budget surplus; the North American Free Trade Agreement; the setting of the inflation-reduction target in the late 1980s; the resulting rapid reduction in short-term real interest rates (i.e., an easing of monetary policy) prior to 1995; the reduction in long-term interest rates (after 1995), as a result of lower inflation expectations, and lower risk premiums; and finally, the strong recovery in the global economy, particularly in the U.S. and China.
To argue that the fiscal austerity alone created the economic and fiscal turnaround in the second half of the 1990s is without merit.
Contrary to Crowley’s assertion, without these reinforcing factors to support economic growth, the 1995 austerity program would definitely “have produced a massive slowdown in the economy”. The austerity policy imposed in the EURO in recent years demonstrates this, and even the IMF now understands that it is not possible to solve a debt problem without economic growth.
Given Crowley’s view that austerity promotes growth, it is not surprising that he also believes “deficits don’t promote economic growth”. Most observers believe that the temporary stimulus applied by the G20 did help mitigate the decline in global GDP in 2009-10. Growth recovered strongly in Canada in 2010 as a result of the stimulus. But with the beginning of restraint in the 2010 budget, growth fell off steadily in subsequent years and the economy has been operating below potential ever since.
Crowley argues that the “output gap” in Canada is rather “modest (only 0.5% in 2015) and according to the OECD will disappear in 2016. But, most Canadian private sector forecasters are projecting that the economy will continue to underperform for the next couple of years. In addition, the risks are on the downside. Economic growth could be lower and the output gap could widen.
But the real question is not the size of the output gap but rather why has the economy been operating below its potential for so long? According to Conservative orthodoxy, shrinking the federal government would allow the private sector to start investing. So why didn’t it? Could it possibly be there was simply not enough demand in the domestic and global economy to make them feel confident in the future?
Normally, after a recession, output will recover back to its potential. But this did not happen in most OECD countries after the 2008-09 global recession. Instead, their economies continued to operate below potential. The result was inadequate levels of investment; low employment rates; high levels of long-term unemployment; low participation rates; high youth unemployment and a less employable labor force. The net result is a reduction in both actual and potential output. There is growing evidence that the level of potential GDP has declined in many OECD economies (including Canada) since 2010, compared to projections of potential output made in 2007.
For years, monetary policy has been the “work horse” in most advanced countries to support economic growth. But monetary policy has become exhausted and there is little more it can do. The IMF has been recommending for years that governments with sustainable fiscal positions (like Canada, with a debt-to-GDP ratio below 30% and falling) should undertake new infrastructure investments to strengthen short-term demand, and long-term potential output.
One last point; most politicians would agree that government’s need to show fiscal discipline in managing their budgets. There is, however, considerable difference over what this means or how that commitment should be implemented.
Crowley takes the view that all deficits (except during recessions) are bad and once governments start spending, they will lack the political will to stop. Better to avoid this by never running deficits.
No doubt there are risks associated with running deficits. But the consequences of doing nothing to support economic growth are far greater. The consequences of doing nothing over the last five years are abundantly clear.