When assessing the dismal fiscal situations of governments around the globe, the more pessimistic among us may tend toward the view that nothing can be done and ultimately everything will end in default, debasement of currencies and inflation. We economists, being dismal scientists, tend to be particularly grim in this exercise.
Even worse, if we are trained in a Chicago or Austrian tradition, which ultimately sees all the bad things coming from the government, we will not only be grim but also very cynical. Politicians can often only be moved by self-interest and the willingness to be reelected at any cost. Hence, enforcing tough measures to preserve a country from default is not a likely scenario. However, historical precedents have shown that becoming frugal not only can be done, but can even lead to reelection of the government implementing such measures.
In 1993 the Canadian fiscal situation was hopeless. According to OECD data, the government debt to GDP ratio in Canada was at 96% (it would cross the 100% ratio two years later) while the public deficit was hovering around 9% of GDP. The newly elected government inherited basically an “all but bankrupt” country. But within five years, by systematically reducing government expenditures, it managed a spectacular turnaround from deficits to surpluses, which would actually last for almost a decade, reducing the Canadian public debt from over 100% to roughly 60% of GDP. On a side note: this Canadian government got reelected twice (in 1997 and then again in 2000).
In a recent talk reported in the UK newspaper, The Guardian, former Canadian Prime Minister Paul Martin, who was Finance Minister in the mid-1990s and hence one of the main architects of this turnaround, explained one crucial element behind its success: “Cuts in government hurt people. If they are made by a government, whose only goal is to make the bankers happy, they will never be acceptable. Deficit elimination must be seen to be essential to people’s wellbeing. It will not be supported because of arcane economic theory or simply because business calls for it. Our message was not that servicing the public debt was crowding out private sector investment; it was that the servicing of excessive public sector debt was crowding out needed social programs: health care, education and child welfare.”
No one should be so naïve to believe that the Canadian story’s happy ending is the usual outcome, but no one should be so pessimistic either to think that any effort to correct a hopeless fiscal situation is doomed to failure. What it takes is courage from politicians to do something about it, and a narrative for the broader public that not only focuses on technicalities like Maastricht criteria but also on the fact that taxes should have a better use than just servicing public debt.
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