Fri, Aug
22
2003

The Myth of the Liberal Deficit

Fri, Aug 22, 2003

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Despite the fact that Canada's economy is moving steadily, and the outlook is good for the future, there are a couple of albatrosses around our necks. One such albatross is Canada's $536 Billion debt.

At current interest rates, our federal debt is costing at least $16.08 Billion each year to service, or $518.71 for every man, woman and child in the country. This is better than the United States, where a $6.2 Trillion debt translates into $77.5 Billion of annual interest costs, $33.3 Billion of which is exported out of the country to foreign bond holders, but still... I'm talking about $16.08 Billion as if it was small potatoes and it's not. It's wasted money that could be better spent on tax relief, improving our military, bulking up our health care, or meeting any one of a number of pressing social needs in this country. We have a hefty balance on our credit card, it is limiting our options, and the reasonable question that follows is "who put it there?".

For the Canadian Alliance and for the Conservatives, the answer is simple: the Liberals. The nearly thirty year run of deficit spending that put Canada in this hole started in 1969, during Pierre Trudeau's watch. The Liberal party governed Canada for most of those years, and the accusation fits well with the perception that Liberals are high-flying social spenders with very little fiscal sense. But this would be a simplistic answer.

It ignores the fact that for almost a decade, the Conservative party of Canada governed the nation, and deepened the rate of deficit spending. Roughly half of the current debt was accrued by Brian Mulroney's administration. It also ignores the fact that deficits were common throughout the western world between 1970 and 1997; the United States had a hefty one, despite having a Republican president at the helm for all but nine of those years. Margaret Thatcher ran a deficit in England, as did Francois Mitterand and Helmut Kohl, and the European Union together maintains a debt of roughly $5 Trillion. Regardless of whether you were liberal, conservative or socialist, if you had a democratic and capitalist system, everybody was doing it.

All of these deficits started in the early 1970s. Clearly, not every government in the western world suddenly turned into mindless spenders. Clearly, what occurred to Pierre Trudeau's administration, and Brian Mulroney's following, was not their fault, nor was it limited to Canada.

It's a little known fact that the Canadian government emerged from the Second World War with a debt that was (after adjusting for inflation) far larger than the debt burden of 1997. This debt was largely paid off by 1970, thanks to massive surpluses fed by economic growth in the Western world unheard of in the history of human civilization. The Western World had a near monopoly on industrial output. Strong unions ensured that workers in factories earned huge incomes which fed large families and generated substantial economic activity, which of course fed more industrial growth and increased tax revenues. The Canadian and American economies were enjoying good times, subsidized by high-paying, low skill jobs and an extremely cheap energy supply (especially oil).

During this time, minor fluctuations in the economy were easily handled. If economic activity outpaced growth, causing a scarcity of goods and thus inflation, the government raised interest rates, encouraging people to save more and spend less. Factories would lay off workers, and decreased demand would lower prices. If unemployment got to be too high, then the government could lower interest rates, encouraging spending, increasing the demand for goods, and the labour to produce them.

Incidentally, this is why Economics is considered "the dismal science" -- the economic goal of lower inflation is achieved by putting people out of work, stressing families, and lowering the number of people who can't afford to pay the prices offered. It does turn one's stomach to think about it, but the formula worked, until 1973.

In 1973, cheap oil disappeared. OPEC formed and launched an oil embargo on the West that quadrupled the price of the commodity. The price of energy soared, meaning the costs of production soared, meaning that profits dropped, meaning that prices rose, meaning that the average citizen found that his working wage paid for a lot less than it did a year before. Anybody protected by a union often saw their wages rise to compensate, which added more costs to production, which feed back into the whole loop again. Some companies went bankrupt. Others had no choice but to lay off workers.

For the first time since the end of the Second World War, western governments encountered stagflation, high unemployment coupled with high inflation. If governments raised interest rates to lower inflation, they put even more people out of work. If they lowered interest rates to get those people back to work, inflation would go out of control. Teachers were striking in Toronto because they felt that the offer of a 25% increase of wages was too low, and already 10% of the population was out of work. Something had to be done, but what?

What had happened was that an external pressure had been applied to the economy, making it a lot more expensive to live and work. Unless cheaper sources of energy could be found and exploited, the only reasonable solution was to ask everybody to live with the additional cost -- to accept the fact that their dollar wasn't going to buy as much, and that the whole nation had just become poorer overnight.

After almost three decades of strong growth, this policy ran counter to the expectations of every citizen in the west. And the governments of Canada, the United States and Western Europe, being democracies, had no choice but to respond to the voters' choice. But how do you lower inflation and unemployment at the same time? You raise interest rates. When this puts people out of work, you get people back to work by paying for projects that put them to work. If this doesn't work, you increase their unemployment and welfare benefits so the unemployed can continue to feed their families. With tax revenues dropping, especially in terms of what the money paid for, the government wasn't going to meet these obligations and balance its budget. So it decided to borrow against its future. It spent more than it took in. It injected money into the economy now by taking it away from the next generation. And the people were happy.

Keynesian economics argues that it is good policy for governments to borrow money in bad times and pay it back in good times in order to moderate the highs and lows of those times. Keynes didn't see deficit spending lasting for more than four years, however. For a while it looked as though the theory would hold true, as the oil crisis faded by 1975. Energy was cheap again, but the deficits weren't reigned in. Something was still dragging down the economy.

Two things fueled the economic growth of the fifties and the sixties: cheap oil, and high paying industrial jobs. Cheap oil was back, but the industrial jobs continued to disappear. Throughout the seventies, the western world lost its monopoly on industrial output to the developing economies of Latin America and the third world. These countries, new to the industrial game, had all of the corporate joys of the early industrial revolution: top-notch technology, little government regulation, and no unions. Workers in Mexico were earning in a week what some workers in Ontario or Michigan were earning in an hour. Corporations could not help but be tempted by that, especially considering that their factories were aging and in need of investment. The rust belts of the American Northeast and Midwest formed, and the highly paid industrial workers that had been the mainstay of the North American economy found themselves out of work.

The situation was just like the oil crisis, but with no hope of resolution. Economic activity hadn't just become more expensive, it was just gone. The public at large was being asked to do more with less. Again, they resisted. And the governments they elected could only respond by borrowing against the future -- a future that seemed to be further and further away.

In Canada, only Alberta escaped the initial rush of provincial deficit spending in the early 1970s, thanks largely to its oil-based economy. But it too was suffering from the loss of high paid industrial jobs to the developing world; when OPEC tried a different tack in 1980 and flooded the world with cheap oil, recession hit Alberta, and its first deficits appeared. An economy that dependent on oil has little resiliency elsewhere, just like the rest of the nation.

Gradually, things turned around. We learned to do more with less. One income, two-parent families were common in the early 1970s; they're almost unheard of today. The purchasing power of North Americans has dropped in the past thirty years. More encouragingly, the highly educated workforces of Canada, the United States and Western Europe also developed new economies that resisted competition from the cheap and dirty. A different class of worker started earning money and paying out taxes. The economy recovered, interest rates dropped, inflation disappeared, and so did the deficits.

In Canada, this also happened under the Liberals watch. But, as you will see, crediting the Liberals for our surplus is as inaccurate as blaming them for the deficit.

Next: The Myth of the Liberal Surplus.


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