Federal Budget 2017—Ottawa should learn from Canada's last road to debt
The November 2016 federal economic update projected persistent deficits from 2015-16 to 2021-22. Shortly after, the Department of Finance released projections, which saw federal deficits persisting until the middle of the 21st century.
If the federal government adheres to its current track, by fiscal year 2021-22, Canada’s federal government will have accumulated $130 billion in deficits. While the deficits are projected to be relatively modest at close to or below 1 per cent of GDP, it remains that a substantial pile of debt is being acquired.
As we await Wednesday’s federal budget and follow the federal return to chronic deficit financing, it’s instructive to review the last time Canada embarked on the road to debt from 1970 to 1997. From a small surplus of $140 million in 1969-70, the federal government went on to incur deficits for 27 years—the longest string of uninterrupted deficits in Canadian federal fiscal history.
At first, the deficits were in the range of several billion dollars but by the late 1970s they had surpassed $10 billion and by the mid-1980s were over $30 billion. As a share of GDP, deficits were as high as 8 per cent in the early 1980s and the annual interest payments required to service the mounting debt consumed nearly one third of federal spending by the early 1990s. Federal net debt rose from $20 billion in 1969 and eventually soared to over $600 billion by 1997. As a share of GDP, the net debt rose from about 23 per cent to peak at 73 per cent by 1995.
How did this happen?
The 1950s and 1960s were an era of relatively low interest rates and robust economic growth, and the federal government created and expanded programs which led to increased spending. While this era was also marked by many deficits, because the economy’s growth rate was greater than the rate of interest on the debt, the net debt to GDP ratio actually fell mitigating the effects of persistent deficits. The result was a failure to realize what deficits could do once the economy’s growth rate faltered, interest rates rose, and spending continued to grow—as was the case in the 1970s.
After several decades of prosperity, Canada was ill prepared for the productivity slowdown of the 1970s and the need to exercise fiscal discipline given the imbalance between revenues and spending. The initial deficits were seen as temporary and reversible once economic growth resumed. However, as the economy stagnated, the pile of debt grew and once interest rates rose, the result was a growing debt to GDP ratio and rising debt service costs.
The fiscal hubris of the age that allowed the public finances to spiral so perilously close to out of control is best exemplified by Mayor Jean Drapeau of Montreal who with respect to concerns about the financing of the Montreal Olympics remarked that: "The Montreal Olympics can no more have a deficit, than a man can have a baby." Indeed, the belief that you could spend your way to prosperity via grandiose public economic development projects and industrial development strategies oblivious to any budget constraint was a defining characteristic of the 1970s.
It was only the emergence of the Chrétien Consensus—an implicit agreement regarding the soundness of balanced budgets, declining government debt, smaller and smarter government spending, and competitive taxes that finally brought federal finances under control. Decisive steps taken by the federal government with the 1994 Program Review and the 1995 Budget set the federal government on the path to a balanced budget and by 1997 the fiscal nightmare was over. There began a string of balanced budgets that continued until the Great Recession of 2008-09 and the net debt to GDP ratio fell to below 40 per cent.
Indeed, the rebound in economic growth after the mid 1990s can be partly ascribed to the salutary effects of these policies on business confidence.
We are currently poised again on the road to debt. The lowest interest rates since the 1960s have led governments to believe that they can run deficits and still be fiscally responsible. It cannot last. Unlike, the 1950s and 1960s or the late 1990s, the economy’s growth rate has slowed substantially and interest rates are poised to start climbing given the U.S. economic recovery.
Any claims that this time is different represents a repudiation of the Chrétien Consensus and should be taken with a grain of salt.