Canada, the Northern Tiger?

Commentary, Role of Government, Frontier Centre

Prosperity is a game of relative advantage. If Canada’s federal budget stays in balance, it’s a good bet that our economy will create more of it than our American neighbour’s.

Add it up. A trip to Mars and a moon base, the war on terror and a $400 billion prescription drug benefit “reform”, all evidence that the U.S. government is on an unprecedented spending tear, with increases of 13.5% a year during the first three years of Bush Two. The Economist magazine, which referred to Bush as “Red George” last summer, describes this profligacy as a recipe for “deficits as far ahead as the eye can see.” This supposed conservative is the first American leader not to veto even one spending bill.

How ironic. While many of our own “world is flat” socialists still see unrestrained public spending as a virtue, the majority political consensus understands that deficit spending is very bad news. Sophisticated left-wingers know it undermines the ability of government to fund public services. Indeed, federal finance minister Ralph Goodale’s first speech pointed out that the feds now save about $3 billion a year because they paid down $52 billion in public debt over the past eight years. Absent those savings, Ottawa would now be running deficits again.

Aside from last year’s quickly forgotten free-spending budget, Canada has emerged as a fiscal darling on the world stage. Only Tony Blair’s England has a lower public debt relative to its economy. The possibility that Canada will become a real Northern Tiger, where rock-solid fiscal policies ignite sustained economic growth rate, is no longer laughable. Recall how the unions in Ireland gambled on the long view, and exchanged cuts in government and fiscal restraint for lower taxes. Growth exploded, and the now fabled Celtic Tiger boosted a once stagnant and comparatively poor Irish economy past Canada’s, to among the highest living standards in Europe.

Intelligent and focused restraint allows fiscal conservatives like Paul Martin, Ralph Goodale and Reg Alcock to be compassionate liberals because it soon expands resources available for worthy projects. Disciplined budgets bring stronger economic growth, which allows government to take the proverbial smaller slice of a bigger pie. In absolute terms, we will end up with more for cities and for healthcare, while leaving more money in the private economy for job-expanding investment. This virtuous circle, where public and private resources expand at the same time, is the key to matching the prosperity of our free-spending American friends. To appreciate it better, we need to understand what economists refer to as the “optimum size of government.”

Imagine a continuum ranging between two extremes of government size. At each extreme – zero government, with no roads, courts, policing systems or public services, or total government, where it takes 100% of resources – there is no basis for a functioning economy. Think of the chaos and lawlessness of Papua New Guinea or Sierra Leone’s anarchy and human wreckage. Go the other way, where bureaucrats and politicians own all the means of production, witnessed by such centrally planned disasters like once-Red China or the Soviet bloc’s now collapsed worker’s paradises. Government spending to enforce laws and contracts, protect the citizenry, and develop infrastructure to facilitate production accelerates economic growth, the basis for rising living standards. Past some point, excessive public spending begins to suffocate it.

The theory of optimally sized government has been well researched. Different studies have shown that living standards, including quality public services, are highest where government consumes between 20 and 30% of the economy. It predicts that Canadian growth will accelerate as we return the relative size of government to the level of the mid- to late-1960s, when wealth levels in both the U.S. and Canada were essentially the same. The theory also makes a compelling case for smaller government in Manitoba if the province ever wants to achieve its true growth potential.

Holding steady on the Canadian consensus of balanced budgets and responsible debt reduction opens up intriguing possibilities. It is no coincidence that Canada’s economy has recently outperformed our neighbour’s. OECD figures for 1992 show that government in Canada then consumed 53% of the country’s economy, compared to 38% in the U.S. Fiscal restraint since 1995 has brought the Canadian figure sharply down to about 40%, compared to 36% in the U.S. If we keep our budgets in balance while the spending floodgates open in the south, look for Canada to move steadily towards the sweet spot of the optimum size of government as the Americans move the other way.

The left-leaning Brookings Institution just released a report called Restoring Fiscal Sanity. One of its editors is Alice Rivlin, Bill Clinton’s former budget director. Clinton not only balanced the budget better than Mr. Bush, he increased total government spending by a mere 3.5 % in his first three years in office and reducing discretionary spending by 8.8%. The report proffers “better government” as one answer for deficit control, arguing forcefully that government can be more effective without absorbing a larger GDP.

How true. As fiscal storm clouds begin to scare Canadian politicians, particularly our provincial premiers, they must recognize that a future of better services and higher living standards – the emerging Northern Tiger – depends on holding the course and creating higher performing government. Now is not the time to blow it with more deficits, debt and taxes.