Public Sector Austerity: Why is Canada Leading the Way?

The major economic problem faced by Canadians is a very slow recovery and weak job market, not government deficits or rising debt. But public spending cuts at the federal and provincial level will make the real problem even worse.

And, government spending cuts in Canada seem set to be even greater than in other advanced industrial countries, even though our overall deficit and debt situation is much better. (The data for this post are taken from the Tables attached to the May 2011 OECD Economic Outlook)

Notwithstanding the weak economy, the focus of the Conservative federal government and most – if not all – provincial governments – is on large spending cuts to quickly reduce deficits.

This is the case despite the fact that total Canadian government debt and deficits are low.

Total Canadian net government debt in 2011 is just 33.7% of GDP compared to an OECD average of 62.6% and 74.8% in the US.

Further, interest rates are at historically low levels. The Government of Canada can borrow through 10 year bonds at well under a 3% rate of interest, and provinces pay only slightly more.

The total Canadian government fiscal deficit is already modest, standing at 4.9% of GDP in 2011 compared to an OECD average of 6.7% and the US deficit of 10.1%. (About 60% of the overall Canadian deficit is at the provincial level.)

Net interest payments on government debt are 0.7% of GDP in 2011, well below the OECD average of 1.9% and the US level of 1.9% of GDP.

Despite the weak economy and our superior fiscal position, the scale of fiscal retrenchment in Canada forecast by the OECD – presumably on the basis of fiscal data submitted by governments – seems set to exceed the OECD average.

The general government fiscal balance or total deficit of Canada will, according to the OECD, fall by 1.4 percentage points of GDP from 2011 to 2012, or from 4.9% to 3.5% of GDP. Meanwhile the OECD average deficit will fall by 1.1 percentage points of GDP, from 6.7% to 5.6%, and the US deficit will shrink by 1 percentage point of GDP from 10.1% to 9.1%.

While Canada’s slightly stronger economy will account for some shrinkage of the deficit through higher revenues, most of the reduction will come from cuts to government spending. Total government spending will fall by 1.1 percentage points of GDP from 2011 to 2012 (from 43.1% to 42.0%) compared to 1 percentage point of GDP for all of the OECD (from 43.7% to 42.7%) and 0.9 percentage points of GDP in the US (from 41.3% to 40.4%.)

As of June, 2011 the Canadian job market remained much weaker than before the crisis in October, 2008. The unemployment rate was significantly higher (up from 6.1% to 7.4%), the proportion of the work force with any kind of a job was lower  (down from 63.5% to 62.0%) and the proportion of both part-time workers and involuntary part-time workers has risen sharply. Full-time, permanent jobs remain very hard to find in many parts of the country.

The “real’ unemployment rate – which counts labour force dropouts and involuntary part-timers – was 10.7% in June. And the youth unemployment rate was a very high 14.3%.

The prospect in 2012 is for continued very sluggish growth, with unemployment stuck significantly above 7%. The US economy remains extremely weak due to high household debt, a very weak housing market, and the turn from a weak and inadequate stimulus program to spending cuts. Austerity is also the order of the day in most of Europe.

The OECD and the IMF are now forecasting a very weak recovery in the advanced economies, which will weigh heavily on Canadian exports of manufactured goods given the very high exchange rate of the Canadian dollar.

Outside of the energy and mining sectors which provide relatively few direct jobs, the Canadian recovery is clearly weak and fragile.

Despite the frequent claims by the media that the Canadian economy is in much better shape than other advanced industrial countries, the OECD forecasts the output gap in 2012 will be 2.2%, just a bit less than the OECD average of 2.4% and the US output gap of 2.4%. (The conventionally estimated output gap seriously under-estimates the extent to which economies are operating below potential, but does so in a consistent way.)

The forecast Canadian unemployment rate for 2012 is 7.0%, just a bit below the OECD average of 7.4%.

Public sector austerity will have negative impacts on growth and job creation across the advanced economies. According to IMF staff economists,  a 1 percent of GDP fiscal consolidation reduces real private consumption over the next two years by 0.75 percent, while real GDP declines by 0.62 percent.

The key question for Canadians is why we are taking the lead in imposing austerity, even though our economy is weak, and even though our deficit and debt situation is superior to most other countries.

The priority in the 2012 federal and provincial Budget round should be maintaining the momentum of the recovery and creating jobs, not artificially speeding the pace of deficit reduction through counter-productive spending cuts.

23 comments

  • It seems useful to set out parameters rather than simply talking about direction. How big a stimulus would be too big? How many jobs created would be too many? The CCPA report you contributed to suggested holding unemployment at 6.2% in 2012. Is your goal a 0.8% reduction in the unemployment rate compared to current targets?

  • @ Andrew,

    “The priority in the 2012 federal and provincial Budget round should be maintaining the momentum of the recovery and creating jobs, not artificially speeding the pace of deficit reduction through counter-productive spending cuts.”

    To the extent that austerity stalls recovery and thus tax revenue and thus a reduction in the expenses generated by the stabilizers they may in fact reduce the pace of deficit reduction. There is more than a whiff of penny wise pound stupid floating around official policy circles in the OECD.

    It is fun to read the General Theory in the present context because much of it can be digested via the perspective of Keynes’ palatable incredulity at just how stupid his ruling class friends (including the intelligentsia) were being. Krugman will be as entertaining in 70 years time though not as original.

  • @ Donald,

    Interestingly the average rate of unemployment for Canada since 1960 – 2009 is about 7.5% so you could make the argument that the BoC is targeting below the natural rate. But to speak of targeting is remiss because they do inflation not unemployment targeting.

    They sleep well by reminding themselves that the existence of a natural rate of unemployment is not contingent on how close to their hearts the burdens of unemployment are.

    Rinse, re-use, re-cycle!

  • Seems like a simple enough question. If you think unemployment is too high, what’s a tolerable rate? CCPA said about 6.2% next year. Is a 0.8% difference what divides neoliberals and progressives? If it is only a “good start” or something, why would you tolerate millions unemployed on a whim?

    In 1997, the NDP promised reducing the unemployment rate to below 5% through a massive fiscal expansion. Now the NDP says they support central bank independence and don’t support a second stimulus.

    Here’s a wild idea: Maybe you can’t have full unemployment under capitalism. Maybe socialists will have to… support socialism.

  • Nice to see Barrie McKenna pick this up for his Globe blog. What with the slagging of Nycole Turmel this week, along with references to her last week by two reporters as a “union boss” I am about ready to kick my daily Globe habit I started when I joined the Dept. of Finance in June 1966. It seems the news has moved to the blogs. So long as you can find the obits, letters to the editor, and John Doyle online, why bother with the paper?

  • @ Duncan

    Yes that was downright anti-NDP. Seems like the Globe has orders to destroy the NDP. I would not be caught lining my bird cage with that rag. Who needs newspapers anymore. I cannot stand being held hostage, truly, it is an weird feeling when I pick up a newspaper now days, why I ask myself when I can go online and learn what really is going on in the world from so many different sources. I think this whole phone hacking shows how low and desperate the media has become.

    @ Andrew
    This Canadian austerity trip is quite confusing, just when Harper thinks he can start cutting- something he has been waiting for so long, as he was dragged kicking and screaming last time he was to commence with the grand assault, saved by the opposition parties threatening a coalition and the onset of the recession. Now he has a majority and the winds of further recession are blowing quite strong from the south. I do wonder if his inner demon is that demented that he will send even more of the working class to the economic tower to rot, and cut regardless of the recession that is coming north.

    Will the grand conservative assault of the far right libertarians be delayed once again? Will Canada survive much longer as we continue to be returned to a resource extraction economy as manufacturing and other high value adding jobs are killed by a mighty than need be petrol dollar? Will Nycole Turmel last another week before the Globe has her in the guillotine for being a traitor to the country.

    Talk about traitors-

    Did anybody happen to see the BBQ pictures of TO mayor Rob and his guests from the weekend? Mr. Harper and Mr. NeoMedival Axeman himself Flaherty all sipping imported beer and BBQing shark? We just needed Mr. Clement and I would have for sure lost my lunch this afternoon. All thanks to Kim E.

  • @Duncan,
    I just read the GM to touch in with what ruling class would like to see happen and how they like to view the world. In that sense it is very informative. But quite right no need to have the physical rag cluttering up the recycle bin.

    @Paul

    One of our favourite VSP economists was in the G&M economy lab section lauding the virtues of Dutch Disease. Too bad he does not really understand what the consequences of Dutch disease really are.

  • Duncan – I would target a high employment rate with low levels of involuntary part-time employment and precarious self employment. That said, the pre recession unemployment rate was 6% with no sign of wage led inflation and I think we could and should get back there, and then work to lower it and see what happens in terms of inflation. The problem with NAIRU theory as embraced by central banks is that it means we never test the limits of capacity. As Jamie Galbraith has argued, breaching NAIRU would not be falling off a cliff, but testing the waters, like going for a swim from a beach. If we do get wage driven inflation at say 5.5% unemployment then the Bank will clearly have a serious point

    Ultimately I would argue that we can have very low unemployment and low inflation – as in Sweden in the Golden Age – but only if we have strong unions which recognize that serious trade offs have to be made. Thanks for your comments.

  • Andrew still hasn’t demonstrated a) how Canadian austerity is more severe than in other places (since it hasn’t happened) and b) how Canada is taking the lead, since the Europeans and U.S. local governments have actually chopped public sector jobs, cut pension benefits and the like.

  • It may be shown, however, that the stimulation of private investment does not provide an adequate method for preventing mass unemployment. There are two alternatives to be considered here. (i) The rate of interest or income tax (or both) is reduced sharply in the slump and increased in the boom. In this case, both the period and the amplitude of the business cycle will be reduced, but employment not only in the slump but even in the boom may be far from full, i.e. the average unemployment may be considerable, although its fluctuations will be less marked. (ii) The rate of interest or income tax is reduced in a slump but not increased in the subsequent boom. In this case the boom will last longer, but it must end in a new slump: one reduction in the rate of interest or income tax does not, of course, eliminate the forces which cause cyclical fluctuations in a capitalist economy. In the new slump it will be necessary to reduce the rate of interest or income tax again and so on. Thus in the not too remote future, the rate of interest would have to be negative and income tax would have to be replaced by an income subsidy. The same would arise if it were attempted to maintain full employment by stimulating private investment: the rate of interest and income tax would have to be reduced continuously– Michal Kalecki Political Quarterly (1943).

  • Andrew, thanks for your reply, I appreciate it. With long policy lags it seems difficult to imagine how central banks could efficiently play around and see what the limits of capacity were beyond what they already do, especially since it wouldn’t want to cause accelerating inflation and then have to slam down on it without knowing the bounds of this move. Perhaps Galbraith has worked that out, though. In any case, that seems more like a technical question and not something to cast aspersions on the central bank as some have done.

    I’m sceptical that old-style “mass worker” unionism (in the autonomist sense) will survive much longer, though, so I’m sceptical of models that depend on a new corporatism.

  • “With long policy lags it seems difficult to imagine how central banks could efficiently play around and see what the limits of capacity were beyond what they already do, especially since it wouldn’t want to cause accelerating inflation and then have to slam down on it without knowing the bounds of this move.”

    As opposed to what? They are already doing this: on the downside. Just what do you think the present conjuncture is about? Boggles the mind this kind of clap trap in the face of experience. It is not 1970 what what, get another frame of reference.

    The CBs are in the panic room. Their whole world view is crumbling. OMG really there is more to economic life then price stability! In fact it is the 1970s what what, but the shoe is firmly on the other foot.

    It is your show be prepared to own it.

    To err is human, to systematically err is insanity.

  • Hey Donny,

    But it is okay for the BOC to play around with mass unemployment? Wow your words are so loaded with bias, typical economist from the orthodoxy- so busy lapping up the cultural slop being shoveled, no time to look up and see the world. Sorry but you pretty much earned that one. Never eat yellow snow.

  • I do have fairly orthodox views of economics in some respects. I think that mainstream economists (say, center-left academics) do a good job explaining how various policy problems work and possible efficient ways to address them. Liberal political theory also seems very useful in constructing notions of justice. Keep what is useful, improve on that which isn’t. Being a socialist doesn’t mean that no one knows anything except you.

  • I agree with Andrew’s point at 12:02 regarding targeting a lower unemployment rate. I believe this should be done through job creation oriented fiscal policy not monetary policy. Changing interest rates for the entire economy is too broad a measure. Targeting high unemployment cohorts and regions should reduce the danger of triggering wage led inflation. It could also provide us with much needed social services.

  • It is for sure a regional issue we are having here in Canada and again it is the problem with generalizing policy tools at some level that they become ineffective and in many cases detrimental. Again it is another case for why monetary policy in Canada is very inefficient and destructive way of treating the patient.

    We have a regional problem, and not the traditional sense of regional problem as it is now east and center in need and monetary policy being applied (intervening with inflation posturing stoking a rise of the dollar, like Carney did in his last rate decision). Add on the liquidity trap dynamics and a return of fiscal stimulus is needed. (actually much of the employment losses today in the LFS was a continuing assault on the public sector, which given multipliers will soon leak back into the private sector and make the whole regional employment issue much worse).

    So fiscal stimulus at a minimum means, for the sake of regional economic disparity do not continue with the austerity.

  • Unless I’m mistaken, it appears here that austerity doesn’t mean deliberate downsizing of the public sector — as it does in other countries, who can only borrow at exorbitant rates — but merely whether to mount a new stimulus programme as the old one expires. Am I correct? I would think that these are two very different issues.

  • Scot – see my latest post for numbers on the cyclically adjusted budget balance from the IMF which show how much of deficit reduction is policy induced – they are the ones best placed to see how much austerity is in the pipeline.
    And this means real cuts or tax increases not just the lack of a new stimulus program.
    http://www.progressive-economics.ca/2011/08/05/more-on-public-sector-austerity-in-canada/

  • It seems to me that our ‘superior fiscal position’ is precisely because our Liberal and Conservative governments stopped listening to the Keynesians and the progressives in 1994. If the NDP had been running the government, we’d be in a situation more like Greece today, rather than wondering if we should balance our budget in two years instead of five or six.

    In 2001, the U.S. responded to the recession by following Keynes’ prescription – the government borrowed money and poured it into the economy through tax cuts and spending increases. In Canada, the Martin government resolutely continued with austerity – our debt dropped every year from 1994 to 2008. It was done with a 7:1 ratio of spending cuts to tax increases.

    The result was that the U.S. became mired in debt, and we got our debt under control. And we went from having a structural unemployment rate 2% higher than the U.S.’s in 1990 and a dollar worth 80 cents American, to an unemployment rate 2% lower than the U.S’s in 2011 an a stronger dollar than the U.S. Oh, and we still have our AAA credit rating.

    And yet progressives are still calling for more spending. Why, exactly? You live in the country that has been the best example of why it’s smart to avoid the Keynesian trap. We tried big government from 1969 to 1990, and smaller government ever since. It’s very clear which one is superior.

  • Dan

    Our problem in the early 1990s was not out of control government spending but the excessively high interest rates imposed by John Crow in search of the holy grail of zero inflation. Slow growth and high interest rates fed the debt spiral. Not just progressive economists but also Tom Courchene, Pierre Fortin and other mainstream economists agreed that the debt dynamics were mainly driven by monetary rather than fiscal policy. As argued in the CCPA Alternative Federal Budgets at the time, the deficit and debt could have come down just as quickly through a pro growth monetary policy combined with a slower return to budget balance.

    Your reading of the US is off. Their debt has been rising due to the Bush tax cuts, war costs and the recession – under Clinton the US debt to GDP ratio was falling fast due to growth plus surpluses.

  • The surpluses of the Clinton era are due to exactly two things: the first is that the trend upwards in government growth was halted, and even reversed a bit. In constant dollars the U.S. government grew slower under Clinton than under any other president in the last fifty years. The second advantage Clinton had was the tech bubble, which drove government revenue through the roof in his second term. A combination of fixing the size of government while letting revenues increase caused the surpluses – just as they did in Canada.

    Canada’s interest rates necessarily reflect our position vis a vis the United States. Had we loosened our monetary policy to ‘stimulate’ growth, the result would have been a devalued Canadian dollar relative to the U.S. dollar. We could have been back to .65 cents again. In addition, we now have a counterfactual to compare against: Alan Greenspan’s policy of holding interest rates artificially low to stimulate the economy resulted in smoke and mirrors – an economic bubble which fooled investors and consumers into thinking they were richer than they really were, so they borrowed too much and spend too much. The result is the current deep recession in the United States. Canada avoided much of that by charting a more stable, conservative approach that emphasized sound money and an unchanging playing field.

    In the long run, your monetary and fiscal policy has to reflect the real underlying factors of production in the economy. Attempts to ignore those and manufacture your own paper economy through monetary and fiscal policy might work for a while, but eventually there must be a correction. Reality always asserts itself.

    While Keynes famously said, “In the long run, we’re all dead,” that’s only true for suitably large values of the ‘long run’. If that long run is only five or ten years in the future, most of us will get to experience it, as we are now.

  • The claim that current deficits are due to the wars and the Bush tax cuts is not true. The Bush tax cuts caused a drop in revenue of about 2.5% of GDP, but that only lasted for for two or three years. By 2007, government revenue as a percentage of GDP was back to what it had been under Bush before the tax cuts – and at an all-time high. Now, you could argue that it would have been even higher without the tax cuts, but we really don’t know. Certainly I think it’s fair to charge Bush with the the revenue losses in the years before tax revenues recovered.

    In addition, those tax cuts were approved by Democrats, and the Obama Administration actually lobbied to keep the tax cuts on the poor and middle class, and only remove the tax cuts on the rich. That amounts to about 700-900 billion dollars over ten years, at a time when the deficit is over a trillion dollars per year.

    Likewise, the wars are responsible for about 1.4 trillion dollars of the debt, but the debt has gone up more than 5 trillion dollars, with no end in sight.

    Projected over ten years, Obama administration has added a trillion dollars in spending due to the new health care plan, a trillion dollars in various stimulus plans, and another trillion dollars in increases to discretionary spending.

    Therefore, the responsibility for the debt can be blamed in pretty much equal parts on Bush, Obama, and the loss of revenue from the recession. The cost of the wars carries maybe 1/5 of the responsibility – with Obama sharing partial responsibility for the cost of the wars since he increased expenditures in Afghanistan and added new fronts in Libya and elsewhere, while sticking exactly to Bush’s plan in Iraq.

  • “The key question for Canadians is why we are taking the lead in imposing austerity, even though our economy is weak, and even though our deficit and debt situation is superior to most other countries.”

    Welcome to the class war dumbass. There are days when I wonder if any progressive (who are fundamentally capitalists who believe in moderate social spending) need to go back and read Marx.

    The business owners and corporations of the world don’t want a “sound economy” they want to enslave workers. Somedays I wonder if progressives have read anything about human history or have any insight into human nature at all. There will always those who want to enslave others regardless of truth or facts.

    We had slave societies for thousands of years, and you think those power driven human beings are just going to up and change their psychological mentality?

    The left is filled with ignorant pandering sissies in the name of ‘conensus’ and ‘community building’, note to you all: What you are seeing is class war, grab a shield, take a position join the fight, take a stand for fucking something because you all are going to be passed over as the world passes you buy and you are all left scratching your head at the ‘irrationality’ of why human beings don’t get along…

    Get a clue – they don’t want to get along, they do not want community, they want power, control, dominance, wealth for themselves and less for everyone else. That’s it.

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