As Canada’s experience in the 1990s showed, the path to economic growth lies in shrinking government, not growing it
This past weekend, Finance Minister Jim Flaherty encouraged the G20 countries to rapidly implement their stimulus packages, highlighting that his government provided a greater stimulus budget than the G20 countries agreed was needed. While that may be so, his government’s 2009 budget also turned back the clock on Canada’s 15-year record of sound fiscal management and set the nation back down the path of larger, more interventionalist government. If the Conservative government truly wants a more prosperous Canadian economy, it would do well to return to the austerity policies of the 1990s and put forth a plan to reduce the size of the federal government.
Most Canadians are unfortunately not aware of Canada’s 15-year track record of reducing the size of government (1992-2007). Since peaking in 1992, the size of government in Canada — best measured by total spending at all levels of government as a share of gross domestic product — has decreased from 53% to less than 40%, according to data from the Organization for Economic Cooperation and Development. This is a dramatic departure from the 1960s, ’70s and ’80s, when Canada leaned towards ever bigger government.
After years of deficit spending that resulted in a serious debt problem, Canadian governments began scaling back spending beginning in the early 1990s. For example, the federal government led by prime minister Jean Chrétien and finance minister Paul Martin reduced program spending by nearly 10% between 1994/95 and 1996/97, from $123-billion to $111-billion.
Several provinces also experienced reduced government spending at the provincial and local levels. Specifically, Alberta reduced inflation-adjusted spending by nearly 20% from 1992/93 to 1996/97 under premier Ralph Klein; Ontario reduced provincial-local government spending by 6% from 1994/95 to 1997/98 under premier Mike Harris; and Saskatchewan reduced spending by 11% from 1993/94 to 1996/97 under premier Roy Romanow.
As a result of the spending reductions, further restraint and strong economic growth since the early 1990s (itself partially the result of a smaller government), the size of government in Canada fell to 39.0% of GDP in 2007 before increasing slightly in 2008.
Equally important is the gap between Canada and the United States. In 1992, Canadian governments consumed 36% more of the economy than their counterparts in the United States. By 2008, the gap had decreased to just 3%. Indeed, given President Obama’s recent budget, Canada will likely have a smaller government than the United States within the next few years.
But if government spending creates jobs and increases economic activity as many politicians, journalists and activists currently believe, wouldn’t the decreases in government spending Canada experienced in the 1990’s have negatively affected Canadians and our economy?
To the contrary, as governments reduced and constrained spending, a greater share of the resources in our economy was controlled by individuals, families and businesses rather than governments. The result was a robust economy with average inflation-adjusted economic growth in Canada exceeding that in the United States and every other G7 country since the mid-1990s.
The experience of Canada’s austerity measures is documented along with a number of other countries in an important and comprehensive study published by the International Monetary Fund (IMF), “Reforming Public Expenditure in Industrialised Countries: Are there Trade-Offs?”
Economists Ludger Schuknecht and Vito Tanzi studied the economic impact of reductions in the size of government in Canada and elsewhere. They found that Canada was not unique in terms of its dramatic increase in government spending from 1960 through the 1980s. Nor was Canada unique in shrinking its government in the 1990s. Indeed, the size of government in most industrialized countries reached a peak sometime between 1982 and 2002 and in many cases, began to decrease quite dramatically.
Schuknecht and Tanzi grouped countries into two groups: ambitious reformers and timid reformers. Countries were considered ambitious reformers if reductions in government spending as a percentage of GDP exceeded five percentage points. Reformers were also split into early reformers (countries that reached their maximum spending levels by the early to mid 1980s) and late reformers (countries that reached their maximum spending levels by the early to mid 1990s). Canada was classified as an ambitious and late reformer with government spending as a percentage of GDP reaching a maximum in 1992 and decreasing by 12 percentage points by 2002.
Sckuknecht and Tanzi then examined the impact of spending reductions on a host of indicators. A critical finding was that the reductions in the size of government were not accompanied by decreases in economic growth. In fact, in most cases economic growth improved after the reforms took place. In addition, economic growth rose twice as fast among ambitious reformers compared to timid reformers. The lesson for countries is to reduce government spending and do it quickly.
Similar results were found for employment; improvements for ambitious reforming countries were greater than that of timid reformers. The authors also found that the effects on income distribution within countries were small and largely mitigated “by faster growth and by better targeting of public spending”.
While this is of course just one study, a comprehensive body of academic work buttresses the IMF study’s conclusion that the size of government matters when it comes to economic growth and social progress.
After years of significant spending increases, the Conservative government would be wise to return to a spending plan aimed at reducing the size of the federal government. Doing so will provide the fiscal room to reduce economically damaging taxes and create better incentives to encourage economic activity.
The list of potential areas where Canadian governments could reduce or even eliminate spending with very little, if any, consequences on economic growth or social progress is long and includes regional development subsidies, corporate welfare, agricultural supports and broadcast subsidies, to name a few.
Reducing rather than increasing the size of government is the key to a brighter economic future. Our own history provides the evidence.
Niels Veldhuis is director of fiscal studies at Vancouver-based Fraser Institute (www.fraserinstitute.org) and Jason Clemens is director of research at San-Francisco based Pacific Research Institute (www.pacificresearch.org ).