 | Deficits Don't Stimulate |
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Keynes said that deficit spending will boost economic activity. So, extrapolating this logic, says that countries running bigger budget deficits should grow faster than countries running smaller deficits. But guess what? When we compare Canada and the US, the truth is the opposite. Canada has run a deficit of about 4.5% of GDP in the past year, while the US has run a budget deficit of 10% for the past two years. But the Canadian economy is out-performing the US economy.
Between 1982 and 2008, the Canadian unemployment rate averaged 2.8% more than the US unemployment rate (see chart). Everyone knew that Canada, despite running a trade surplus and exporting like crazy to the US, was not economically vibrant. It was a commodity based economy.
Today, the unemployment rate in the US is 9.5%. The Canadian unemployment rate should be 12.3%, right? Wrong!!! The Canadian unemployment rate is 8% and falling fast. In fact, the unemployment rate in Canada has been below the US unemployment rate since October 2008 – a huge shift in the relationship between these two economies. No longer is Canada falling behind.
Government spending, because it must be paid for by borrowing or taxing, subtracts resources from sectors not favored by the government. This means that for every job created there is a job lost somewhere else. As a result, the larger the government the smaller the private sector and the higher the unemployment rate. History is clear and so is the relationship between Canada and the US. Canada has cut its spending as a share of GDP – from 53% in 1992 to 39% in 2007. During this time Canada ran budget surpluses. It has also cut corporate tax rates (from 21% to 18%) in the past 5 years and back in 2008, Canada even cut its Value-Added-Tax.
The lesson is clear, smaller government, even in times of supposed crisis, is the best policy. Keynes was wrong – dead wrong.
**When the G-20 met during the middle of the financial panic, the directive came down from above (the US, the UK, the EC) - "everyone must run deficits." Partly this was because the fear level was so high, but mostly this was because US politicians did not want the dollar to take a hit. Spending like drunken sailors, when everyone else stayed sober, wouldn't look financially sound. So, the G-20 countries, stepped up, and ran up their deficits. Canada has pushed its spending up temporarily to about 43% of GDP, which has created a budget deficit. However, Canada is committed to a track of lower spending and it is already returning to that more conservative path.
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