The key fiscal lesson of Canada’s first 150 years—spend prudently
As 2017 draws to a close, Canadians can reflect not only on the outcomes of the last year, but in this milestone 150th year of the federation, also where we are headed. What shall Canada’s economic achievements be as the next 50 years unfold? What can we do to ensure prosperity for ourselves and future generations in a competitive and tumultuous world?
At Confederation, Canada was a rural country of approximately 3.6 million people with agriculture comprising 40 per cent of the country’s GDP, a total output in 1870 of $388 million and real per capita GDP (in 2014 dollars) at $2,700. From this start, Canada grew into one of the most successful countries in the world with an enviable standard of living. By 2015, Canada’s GDP was nearly $2 trillion and its per capita GDP (in 2014 dollars) was approximately $55,000. Its population is now 85 per cent urban and our major cities regularly top international rankings for livability and quality of life.
While we are the 37th largest country in the world in terms of population, we are the 11th largest economy in the world, have the 19th highest per capita GDP, are the 10th largest exporter in the world, and rank 9th on the Human Development Index.
The long-term determinants of our success have been threefold. First, Canada has been blessed with stable political institutions and a general quality of government that allowed people to flourish and achieve their potential.
Second, we have been an open export-oriented economy with substantial immigration and capital inflows and approximately one-third of our GDP earned via exports of goods and services.
Third, we have historically embraced the institutions of a market economy and the public value of fiscal responsibility when it comes to government involvement in the market economy.
Until the Second World War, Canada’s federal and provincial governments saw their role in terms of a laissez-faire classical liberal state. Key responsibilities were institutional infrastructure with government spending concentrated on transportation and communication networks. The post-war period saw a transformation of government into a more interventionist role via spending on economic development and health, education and social welfare. The role of government as the provider of core public goods within a liberal market economy shifted to one of government as a source of redistribution and social investment. Taxes and spending as a share of GDP rose accordingly.
As the economic role of government expanded in 20th century Canada, governments lost sight of the law of diminishing returns. While government spending and activity can yield benefits, more government is not always better, especially if accompanied by growing debts and deficits. Starting in the 1970s, government finances lost their way, especially at the federal level, as deficits compounded into mounting public debt that culminated in the fiscal crisis of the 1990s. This placed in jeopardy many of the government programs Canadians had come to rely on as debt-service costs rose.
It was only the decisive steps taken by federal and provincial governments to return to balanced budgets—the Chretien consensus—that paved the way for the substantial economic growth and progress made after the late-1990s as the benefits of sound public finances and free trade took root.
When it comes to guidance for future growth and prosperity, the fiscal lessons of the last 150 years can be summarized as follows. Used prudently, government spending is useful, but the key policy decision is when should government do something and when should government leave things well enough alone. When spending public money, the key considerations are when to spend, what to spend it on, how much to spend, and how to pay for the spending. Getting the wrong answer to any of these questions has fiscal implications that can affect the welfare of Canadians for decades.
Clearly, Canadians should be nervous as their governments embark on a new era of spending that’s accompanied by growing public debt.