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Canada’s redemptive decade: Lessons for Bermuda

“A democracy cannot exist as a permanent form of government. It can only exist until the people discover they can vote themselves largesse out of the public treasury. From that moment on, the majority always votes for the candidate promising the most benefits from the public treasury, with the result that democracy always collapses over a loose fiscal policy — to be followed by a dictatorship.” — Alexander Fraser Tytler

It may seem to some that Bermuda's national fiscal situation is beyond repair. Deficit projections seem to be projected far into the future and growth has been elusive and starkly negative. Up to this point few, if any, efforts have been made to arrest the escalation of indebtedness and the really tough choices have not been enacted. Fifteen years ago, Canada faced a fiscal crisis. Canada's story is remarkable and probably something we can aspire to here in Bermuda. There is a lot we can learn from the efforts of our neighbour to the north to restrain government and adopt market-oriented reforms to spur strong economic growth.

Up until 1975, Canada's public debt grew at rate of about five percent to ten percent per year before it exploded upward. In the 12 years following 1975 the country ran budget deficits that resulted in the debt actually rising more than 20 percent per year. Budget deficits ran at about eight percent of GDP in 1983 and 1984. By 1995, Canada had a net debt to GDP ratio of about 70 percent and the second worst fiscal position in the Group of Seven industrialised countries, only behind chronically profligate Italy. In those days, the Canadian dollar became mockingly known as either the “Loonie” (after the bird on Canada's $1 coins) or the ‘Northern Peso'. The situation was so dire that the Wall Street Journal ran what turned out to be a pivotal article in which the authors asserted that Canada had become “an honorary member of the Third World in the unmanageability of its debt problem”.

How bad was it?

• By the mid-1990s, one-third of all government revenues or about five percent of GDP was being devoured by interest costs on Canada's rapidly escalating debt. Simple debt arithmetic suggested that this was unsustainable.

• Canada had also become one of the developed world's most socialised economies, with the government accounting for 53 percent of the country's GDP.

• By 1995, at its peak, Canadian federal and provincial government debt amounted to 120 percent of GDP.

• Canada's interest rates were rising due to worries about the nation's solvency. Its coveted AAA credit rating was yanked, and the market was treating it as an increasingly unreliable borrower.

With their backs against the wall and conditions looking grim Canada's politicians got serious about tackling the problem. In November of 1993, a new Liberal government lead by Prime Minister Jean Chretien and its party finance minister Paul Martin took a look at the books and got to work. Paul Martin has been quoted as saying: “Debt and deficits are not inventions of ideology. They are facts of arithmetic.” Chretien eventually earned the nickname ‘Dr NO' for his staunch denial of requests that escalated spending. Canada essentially went from being a “basket case to world beater”. So what exactly did they do?

• Paul Martin unveiled a budget in early 1995 that reduced programme spending by 8.8 percent over two years. During the reformation, cuts ranged from five percent to 65 percent of departmental budgets.

• Canada drastically shrank the overall size of its government. As part of this radical spending rationalisation, federal government employment was reduced by 14 percent with some Ministries being cut in half. The 1994 budget went from 54 programmes down to 11. Ministers were simply told they needed to cut and had to come up with a plan to do it.

• Federal grants to the provinces (which are often used in welfare programmes) were also reduced by 14 percent, and defence, foreign aid and unemployment insurance entitlements where reduced. Despite accusations from socialist or more liberal proponents that the poor would suffer due to these changes, the percentage of welfare recipients actually fell in just a few short years from 10.7 percent of the population to 6.8 percent by 2000. In fact, from 1997 to 2007, the percentage of Canadians classified as low-income plunged by over 30 percent.

• While some taxes were raised, spending cuts were more than four times greater than tax hikes. In fact, personal income and capital gains taxes were reduced and corporate tax rates were reduced by a third. Some of these tax reductions were offset by the consumption tax (the Goods and Services Tax) used during the period.

• The Canada Pension Plan (CPP), the country's version of Bermuda's Contributory Pensions Fund, also underwent major reform. Instead of payroll taxes gradually rising to 14 percent, the increases were pulled forward rapidly but capped at just under ten percent. This produced immediate surpluses that were subsequently invested in higher-returning corporate securities. Today the Canada Pension Plan is well-funded and actuarially solid.

• The government privatised Canadian National Railway in 1995 and about two dozen “crown corporations” in the late 1980s and early 1990s. In 1996 it even privatised the air traffic control system.

As a result of these actions, and many others I've left out, the federal budget was balanced by 1997 and the debt to GDP ratio showed a decline. Programme spending fell by 12 percent or $14 billion between 1994-95 and 1998-99. The country went on to run 11 straight annual surpluses and slashed the annual debt from about 80 percent of GDP to just 45 percent. In fact the foundation set from prudent fiscal consolidation helped establish a base from which Canada led the G7 in economic growth, job formation and investment from 1997 to 2007 and helped it weather the 2008 financial crisis better than most.

Four things to learn and consider:

1) Not all taxes are created equal. Some have a much more negative impact on economic activity than others. A local Value-Added Tax with other tax concessions may help offset needed cuts in spending.

2) A huge reason why this plan worked was the fact that the Canadian currency tanked. Canadian goods became very inexpensive on world markets, thereby stoking demand. Canada's real estate became attractive to both American and other foreign investors, drawing in massive amounts of hard currency into the country. This is the vital missing link for countries like Bermuda where we are still nowhere near cost competitive on some aspects.

3) Hardcore Keynesians (those who believe government spending should never be cut) often predicted Canada's grand experiment would be an abject failure. Yet, despite all those who were sure that downsizing government would do the same to their growth rate, Canada's economy grew at 3.1 percent per year versus the G7 average of 2.9 percent from 1993 to 1997.

4) You can cut and win elections. You can also be a liberal government and cut spending! Chretien actually went on to win two majority governments through the reformation period.

As you can probably tell, Bermuda does not have the ability to control several of the factors that helped Canada out of its problem. A few big reasons why this will not be so easy for Bermuda:

1) While Canada was cutting and resizing the world economy was booming (especially its neighbour the US). This created a source of external demand for what Canada produced and Canadian wares were cheap because of the recent collapse of its currency. No other country at the time was really reigning in spending.

2) We really have no way to substantially reduce taxation here. Our taxable base is already very small so we won't be able to offset government cuts with tax rate cuts.

3) We outsource our monetary policy to the US Federal Reserve. The economy in Canada over this period of reformation was not excessively robust and had some deflationary pressures. To help ease in the transition, the Bank of Canada maintained a very loose monetary policy that kept rates very low. Interest rates plummeted 1,000 basis points, or ten percent between 1990 and 1994. Bermuda's private sector lending market does not mirror that of the US nor do rates follow any local prescription for easing. Thus we are not likely to get any relief from the low cost of lending.

4) Furthermore, as noted above, our currency is not likely to depreciate substantially as it is pegged to the US dollar and its weakness is not directly beholden to our own monetary policy unless we de-peg. It's also possible that the inflationary aspects of any de-pegging or depreciation would swamp any benefit to our relative cost competitiveness.

Because of these limitations it is even more important to tackle the fiscal issues early in Bermuda before they grow to a level which will be impossible to extricate ourselves from.

Ultimately I believe that some of the lessons learned from Canada are entirely applicable to Bermuda today. Bermuda's escalating fiscal deficit and budget issues will be fixed once the public demands action and the political class decides to set aside all differences and pursue a focused government. This should help establish a strong base for a prosperous future.

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Published September 16, 2013 at 9:00 am (Updated September 15, 2013 at 2:56 pm)

Canada’s redemptive decade: Lessons for Bermuda

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