Some Caveats on Canada

by Brian Bolduc

In today’s Wall Street Journal, Charles Koch defends his business empire and his free-market ideology. While discussing the latter, Koch argues — contra President Obama — that cutting government spending will help the economy, not hurt it. He offers our neighbor to the north as an example: “When Canada recently reduced its federal spending to 11.3% of GDP from 17.5% eight years earlier, the economy rebounded and unemployment dropped. By comparison, our federal spending is 25% of GDP.”

David Henderson of the Hoover Institute recounts this story in his paper, “Canada’s Budget Triumph.” In 1993, Canada’s economy was sickly. Its unemployment rate hovered around 11.4 percent and the national debt totaled 67 percent of GDP. Moreover, the federal government consumed over 23 percent of GDP. (Sound familiar?)

The next year, however, the newly elected Liberal prime minister, Jean Chretien, and his finance minister, Paul Martin, raised taxes slightly and cut budgets drastically. Unemployment insurance, department funding, defense spending, and business subsidies all took hits. Chretien and Martin continued cutting for years and by 1997, Canada enjoyed a budget surplus of $3 billion — the first surplus since 1969.

Between 1993 and 1997, federal spending on programs — the precise datum Koch cites — dropped from 17.4 percent of GDP to 12.3 percent. Meanwhile, the federal government’s share of GDP fell from 22.3 in 1993 to 15.2 in 2006, when Martin and the Liberal party lost to the Conservatives.

Although Canada’s experience suggests that cutting government spending will not draw forth the apocalypse, a few caveats are necessary. First, Canada benefited from an economic boom in the U.S. — the same boom that made balancing our budget much easier. Second, as Paul Krugman argues, the Bank of Canada pursued a policy of easy money, which helped offset any constricting effects of smaller government budgets.

“My own sense is the Bank of Canada did good things,” Henderson says. “They were kind of like the Greenspan of Canada.”

Henderson agrees with Krugman that this monetary policy and the trade boom played roles in rectifying Canada’s fiscal troubles. But he also thinks the government’s responsible budgeting was in on the act. “What’s really striking,” he tells NRO, “is if you assume Canadian growth depended solely on the U.S. and you look at Canadian GDP in 2001, when the U.S. hit its recession, you would have expected Canada to have a recession. It didn’t.” From 2000 to 2001, the Canadian GDP-growth rate dropped from 5.2% to 1.8%.

Unfortunately, the Canadian leviathan has reinflated recently under Conservative prime minister Stephen Harper. His government implemented a stimulus package in response to the Great Recession two years ago. And the federal government’s share of GDP has ticked up to 18 percent. “Stephen Harper was expected to be the most libertarian prime minister in the last 100 years — and he isn’t,” says Henderson. “He’s the one who’s really reversed most of this.”

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