By Basil Zafiriou *
Canada today is one of the most fiscally sound countries on earth, but that wasn’t always the case. Twenty short years ago, the country was drowning in debt and deficits, with a level of indebtedness similar to that of Greece at the time. How Canada managed to cure its fiscal frailty can help shed light on Greece’s more tortuous path to fiscal health.
As the accompanying chart shows, both Canada and Greece experienced a steady increase in government indebtedness from the early 1980s to the mid-1990s. By 1995, gross government debt in both countries had reached 100% of GDP.
Greece’s debt stayed more or less at that elevated level, until the onset of the recent financial crisis propelled it sharply higher. Canada introduced an ambitious fiscal restraint program in 1995, which put the country’s finances on a path that brought the debt/GDP ratio down to a low of 67% in 2007, before the financial crisis caused the downward trend to reverse.
Remarkably, Canada’s restraint program achieved its targets without adverse effects on output. Economic growth dipped marginally during the first year of restraint, but then accelerated and remained robust thereafter.
Greece too has made amazing progress in rebalancing its books over the past four years, but this progress has been very costly in terms of lost output and jobs. And Greece’s indebtedness has continued to climb owing to a rapidly shrinking economy.
Key factors explaining Canada’s success and Greece’s difficulties
What accounts for the difference in the experiences of the two countries? Greece started its fiscal adjustment from a much weaker position, and the fiscal restraint required was correspondingly greater. But other factors as well favoured Canada, the following being key:
A supportive external environment. In particular, the US (by far Canada’s major trading partner, accounting for over 70% of Canadian exports) experienced strong economic growth during the late 1990s, with GDP growth averaging over 4% annually. By comparison, the EU experienced a deep recession in 2008-09 and a sluggish recovery since.
An accommodative monetary policy. The Bank of Canada rate was reduced progressively from 8.5% in March 1995 to 3.25% in November 1996. The ECB also loosened monetary policy in the wake of the financial crisis in 2008, but reversed course and started raising interest rates by the end of 2010--while the Greek economy was still sinking deeper into recession. (ECB policy has become more stimulative since the accession of Mario Draghi to the Presidency in November 2011.)
A depreciating currency. The Canadian dollar fell from 73 cents US in 1995 to 67 cents in 1998, helping improve the competitiveness of the Canadian economy and strengthening Canada’s trade balance. Being part of the Eurozone, Greece of course lacks the option of devaluing its currency to improve competitiveness.
Strong consensus on the need for fiscal consolidation, and hence widespread public support for the measures taken. Measures taken at the federal government level included a 10% reduction in program spending, elimination of more than 50,000 jobs, privatization of public assets and contracting out of services. Public service unions opposed these measures, but there were no strikes, work stoppages or other coercive attempts to thwart implementation. The government had gone to great lengths to explain to Canadians the need for retrenchment, and they accepted the message. It helped that the official opposition in Parliament was on board. Indeed, its main criticism was that the government was being too timid in its deficit-cutting efforts. Strong support facilitated implementation of the program. It also lent the program credibility, which helped stimulate consumer and investment spending, offsetting the reductions in government expenditures.
In Greece, as we all know things have been very different. Here, virulent--and often violent--opposition to austerity measures slowed the pace of reform, discouraged tourism and drove out investment. The resulting reduction in private sector spending compounded government cut-backs, driving the economy deeper into recession. A shrinking economy meant lower government revenues, requiring even further cut-backs to meet deficit targets.
Since Canada’s fiscal consolidation in the 1990s, the Canadian economy has outperformed the economies of all G-7 countries in growth and job creation. It weathered the recent financial crisis best and exited it first. The experience has taught Canadians to value fiscal prudence and be wary of slipping back into runaway deficits and debts. Political parties across the spectrum are one in their espousal of balanced budgets and low debts. Greece is not there yet. But Canada’s experience can encourage Greeks to look with optimism to their own future beyond retrenchment, and to stay the course.
* Basil Zafiriou is an economist, retired from the public service of Canada