Author: Timothy Lewis
The title uses a famous quote from (John Maynard) Keynes, who said- “The long run is a misleading guide to current affairs. In the long run we are all dead. Economists set themselves too easy, too useless a task if in tempestuous seasons they can only tell us that when the storm is past the ocean is flat again.” Keynes, of course, is a proponent of an active role by government in economy, especially in crises–something that has been discussed ad nauseum in the 2008 and the 2011(?) recessions.
But this is not a book about theory of Keynesian economics. I picked up this book as it offers a parallel between the current state of United States and Canada’s fiscal state in late 1980s and 1990s. Unemployment around 10%, stagnated personal income (0.5% total growth between 1989-98), 30% of employment in nonstandard work, more than 70% Debt to GDP ratio: these were as true for Canada as it is for the US today. Canada walked back from the brink, albeit earlier than US is willing to, where Debt to GDP has crossed 100%.
Are deficits bad?
All deficits are not created the same. Short-run deficits are welcome, as they are a counter-cyclical response to economic under-performance. Governments with their relatively unconstrained balance sheet (in the short-run), can issue more debt and undertake more spending to smooth the business cycle. Automatic stabilizers, which are pre-legislated, also lead to deficits. These are good deficits, as the government becomes the only actor that can support the economy in a recession. But, structural deficits are a very poor bargain. Not only are they fiscally unsustainable, but they also limit the ability of government to undertake more debt in midst of trough of a business cycle.
Deficits may be bad, but what forces governments to change it?
As we all know, just because something is bad doesn’t mean that governments will not do it, if it helps get votes (or, in times of hubris, suits the ruling party’s ideology). Case in point: Iraq war. In case of deficits, what really forces the government to make change?
To answer that, we need to look at the internationalized trade and financial markets. Capital and corporations cross national boundaries, and are bound by multilateral institutions such as GATT and WTO. The state hasn’t disappeared, it has become internationalized. Today, when capital is not bound by regulation, it can turn the supranational governance structures to its own end, disciplining states and societies. (case in point: Greece and Ireland). Anti-globalists have long argued that globalization of trade and finance is serious threat to sovereignty and equality, and they have been proven right on several occasions. I don’t claim this view to be correct, but it is worthy of debate as these fears have come true for the periphery European states.
Globalization certainly hasn’t been the panacea the proponents have argued. It is worth remembering that the world was more globalized before the first world war, thanks to Britain’s economy. Many countries became colonies of this capitalist enterprise. As a citizen of India, where colonization began by intrusion of a global corporation–East India Company, and where economic revitalization accelerated due to globalization of services labor, I am more than conflicted. Like always, “the truth” lies somewhere in the middle. But, we are getting away from the topic at hand.
How long did it take Canada to control its deficits?
It took almost 10 years, and contrary to potential preconceived notions, the Liberals were in power when the rubber met the road. Brian Mulroney’s Progressive Conservative party, who took power in ’84 started the conversation, presenting deficit finance as an enemy of good economic performance, and it was the Liberals, who were elected in 1993, with Chrétien as the PM and Paul Martin as the finance minister, who eventually put the concepts to work. This shouldn’t be taken as a rebuke to Mulroney, as it takes very long to change the notion of role of state in the economy. The shift from liberal capitalism to neo-liberalism, which suggests that state’s priorities ought to included markets before protection of society and economy from its worst tendencies, is significant. There was opposition to this approach, arguing against erosion of social justice, but that argument lost because it wasn’t pro-growth, and presumed that Canada was independent of the world. It only offered a critique, not no alternative solution.
If people have been following the current debate of US federal budget, this should come as no surprise, that one of the first fixes considered was the MacEachen tax refrom, which would close tax loopholes for the wealthy and the corporations. NEP, or the National Energy Program, was a also a part of the first steps, but this was a curiously Canadian concept, led more by provincial politics than fiscal deficits. As one can see, these steps aimed to increase the revenue base, as it was still hard for the governments to sell the concept of cutbacks in services provided by the government.
Social groups are rarely marginalized enough that they can be attacked head on. Arcane technical amendments are used to chop off benefits, proposed modification of inflation indexing in US being a perfect example. Apparently, this is not a new trick. Canada, for example, de-indexed benefits such as family allowance, children’s tax exemption, refundable tax credit and the personal income tax system. It also clawed back security for high-wage earners by ending universality for social programs such as Old Age Security. This is not yet done for Social Security in the United States, but we rest assured that such an amendment will make its way through Senate, if Congress manages to pass this.
Only after these stealth cuts have been passed, will we see a more direct attack on the society’s safety net. Not only is this more politically expedient, but also allows for fiscal restraint to become more popular. In Canada, this fixed the operating deficit while Mulroney was still in house, but the overall fiscal deficit remained in place.
The fixes before helped the fiscal house, but took a toll on the economy (US in 2011, anyone?). When the federal government cuts back in a recessionary environment, GDP slows down, unemployment climbs, real rate of income growth stagnates and inflation goes as monetary policy tries to fill the gap, including trying to fend off deflation. The metrics that I mentioned in the introduction applied to this era.
Tea Party of Canada
Politics of insecurity, whether it be economic, social or simply fear of a Socialist Muslim Kenyan (italics standing for the Sarcasm font), leads to formation of ideological parties or factions within parties that align themselves to take advantage of public insecurity. This also leads to rightward shift of the liberals also. In Canada, Reform Party formed to take the role, and won several seats west of Ontario. This is very reminiscent of the Tea Party’s success in the last Congressional elections.
At the first blush, it makes little sense that Tea Party populace, which is usually economically less well-off, stands up against the welfare state. But, there are two underlying reasons that this happens. First, the individuals feel that they cannot afford the welfare state. Second, they believe that the welfare state will not exist, and thus it makes no sense to pay premiums.
Win The Future
How many times have we heard this from President Obama and his team, only to cringe, as it seems a little hollow. Well, he may be picking it from Paul Martin, Chrétien’s finance minister, who repeatedly mentioned of ‘securing the future’.
If Martin’s playbook is any guide, deficit elimination in the US will be an exercise in strategic withdrawal of the state as opposed to a fiscal retrenchment. Role of the state as a counter-cyclical stabilizer will remain, but the benefits will be less generous. Corporations and consumers will be weaned off subsidies. There will not be across the board cuts, but specific cuts to make the government leaner.
In the latter half of 1990s, Martin made broad cuts in the government spending. There were some tax changes, but spending items such as business subsidies, defence, transport, and public employment were pared at a rapid rate. The playbook seems to be that the state will cut back spending where it will take the least heat from its constituents.
What comes first? – Deficit Reduction or Growth
This is often a point of consternation between the left and the right. Right often portrays deficit reduction as a precondition of growth. But, Paul Martin asserted that deficit reduction is a product of growth, rather than a precondition, and made growth central to the fiscal strategy.
We don’t know how the budget will be balanced in the United States, but given how close the current government has followed Canada’s playbook till now, and how similar the two economies and democracies are, I believe that the eventual result wouldn’t be very different. The US harbors a stronger individualistic trait and hence, the cuts in state spending would probably be more savage. The next few years would be very interesting.
We live in interesting times.