Forgetting the lessons of deficit financing
The upcoming federal budget comes in Canada’s 150th year — an important milestone for what is perhaps the most successful country in the world. The evolution of federal finances since 1867 reflects a changing economy and offers important lessons regarding the perils of persistent deficit spending and growing indebtedness.
Canada’s federal government has indeed grown. In 1867, it had a budget of $14 million, an expenditure-to-GDP ratio of approximately five per cent, a net debt of $75.7 million, and a net debt-to-GDP ratio of 20 per cent. Transportation, communications and economic development accounted for a quarter of federal spending. Meanwhile, debt service charges were 27 per cent due the newly formed federal government assuming provincial debts. There were no transfers to persons.
By comparison, total federal spending in 2017 is estimated at $331 billion with an expenditureto-GDP ratio of nearly 16 per cent and a net federal public debt of $760 billion, resulting in a debt-toGDP ratio of 36 per cent. Assorted transfers to persons and other levels of governments now account for nearly two-thirds of federal spending.
Prudent government spending is useful, such as the construction of the transcontinental CPR railway where subsidies encouraged the building of a risky transportation project. However, the same strategy also saw over-subsidization of the CPR and substantial subsidies to two other less-successful rail lines.
Over the period 1867 to 2017, the federal government ran a deficit nearly three-quarters of the time, with the largest deficits-to-GDP ratios during the two world wars and the great divergence between revenues and spending leading to the 1990s debt crisis. Large deficits and interest rates greater than the economy’s growth rate during the 1970s and 1980s led to a rising debtto-GDP ratio and fiscal crisis of the early 1990s.
The important policy decisions when it comes to spending are when to spend, what to spend, how much, and how to pay for it.
Given the surge in federal deficit financing in the wake of the 2016 budget, one wonders if the lessons of the 1990s have already been forgotten. While interest rates remain at historic lows, economic growth is also low, making a case for fiscal prudence given the dynamics of deficits and debt. The progress made in reducing the federal net debt-to-GDP ratio below 40 per cent will be largely squandered if we allow debt to once again grow uncontrollably.