Why the U.S. can’t ‘just do it’ and implement austerity

by Stephen Gordon

Brian Lee Crowley and Robert Murphy have some advice for US policy-makers on how to deal with its government budget deficit: do what Canada did in the mid-1990s.

Canada faced an even larger fiscal crisis in the mid-1990s than America does today, and our achievement dwarfs anything being proposed in Washington. By acting decisively, Canada resolved its crisis quickly and with surprisingly little pain. Since the memory of this momentous achievement is fading, or is unknown to the younger generation, it is worth recalling how it unfolded.

It is indeed. Unfortunately, the authors don’t mention the parts of the story that show why telling the US to follow the Canadian example of the 1990s is recklessly bad advice.

Firstly, the Canadian austerity program was implemented after the labour market had recovered from the recession of the early 1990s:

 

Public sector employment – quite sensibly – increased during the recession. But Paul Martin didn’t bring his austerity budget until the spring of 1995, well after private-sector employment had recovered the losses from the recession. This story in no way fits the current US experience:

Setting aside a short-lived jump in temporary hiring during the 2010 census, US public sector employment has been on a downward trend for almost four years now, and is now significantly lower than it was at the start of the recession. Moreover, private-sector employment is still well below pre-recession levels. If we’re going to ask the US to follow our example, then it’s far too early to start cutting yet.

The other important point is the significant role monetary policy played in offsetting the effects of the fiscal contraction.

In the months following the 1995 budget, the Bank of Canada cut its policy rate by more than 5 percentage points – a significant level of monetary stimulus that Federal Reserve is struggling to reproduce. Until we know more about how effective this next round of quantitative easing will be, it’s probably not a good idea to assume that QE3 will provide enough stimulus to bring the economy out of recession and offset a fiscal contraction at the same time.

But the biggest reason why no-one should expect the US to handle fiscal austerity as well as Canada did in the 1990s is that we had what the US doesn’t: a rapidly-growing trading partner with an economy 10 ten times as large. A consequence of the Bank of Canada’s accommodative monetary policy stance was a long, sustained depreciation in the Canadian dollar. This made it possible for exports to take up the slack in domestic demand created by government cuts in spending:

The expansion of 1991-2000 was the only one in the last 30 years to have been driven by exports. Although one of the goals of QE3 is to depreciate the US dollar, there is no way that the US can repeat the Canadian experience of the 1990s. The US economy is so large that there simply isn’t anyone who can absorb the sort of export growth needed to offset a fiscal contraction.

Canada was extraordinarily lucky to have implemented its austerity program in almost-ideal conditions: the recession was over, and a fast-growing trading partner that could – and did – make up for weakened domestic demand. The US is not nearly so fortunate.

There’s no point in telling the US to ‘just do it’. They can’t.

 




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Why the U.S. can’t ‘just do it’ and implement austerity

  1. Crowley/Murphy write that US should get its fiscal affairs in order like Canada did in 90s, they don’t suggest that US should do exact same reforms as Canada. American governments need to spend less or tax more, they should decide which.

    It is good idea for all countries to do significantly better job of managing budgets – much deleveraging need to happen before we are going to see real growth again. Frau Merkel is telling a bunch of countries to ‘just do it’ as well but Greece/Spain/Italy/Portugal are not doing too well with reforms either. It is amazing how wedded people become to government programs.

    • Mmmm govt programmes like war, and weapons, and 1000 bases around the world.

      Burns up more money than any personal benefit ever did.

      ‘Imperial overstretch’ has taken out every empire that’s ever existed. It’s now doing the same thing to the US.

      • This particular item belongs in the “But That’s Different” file.

        • LOL yeah, ‘war and weapons’ is always ‘different’ innit?

          My gawd, what we could do with the money spent on just those two things!

    • It’s amazing how wedded people are to not enjoying the prospect of standing in line at the soup kitchen.

  2. Stephen,

    Was hoping you might briefly explain why you believe it is a good idea for public sector employment to increase during a recession? You call this “sensible”, but it is not intuitive to me at all.

    Obviously during a recession, the economy shrinks, thus less tax revenue available…increasing the size of government in such an environment increases defecits/debt rapidly. Why is this preferable to downsizing government expenditure in response to lower tax revenue? What is it about this additional government employment that you feel contributes to getting private sector employment rolling again, that justifies taking on this additional debt?

    Thanks

    • Economic direction is self-reinforcing. If everybody around me is losing their job, I’m going to be losing mine because they can’t afford to buy my crap anymore. Now we’re all losing our jobs, and the people who depended on us to buy their stuff are going to be losing theirs, and so on. Private sector has marked (and sensible) reservations about expanding when everybody is losing their job. Sure they can get the workers cheap, but if fewer and fewer people are buying their goods anyway that’s just throwing a smaller amount of good money after bad.

      If left unchecked, economic downturns like this can bring a country down to subsistence level or lower before it’s able to get its feet under it again (again, simple reasoning.. people cut back on everything they can when nobody’s. However, they still have to eat)

      Cutting government expenditures will do absolutely nothing to halt this spiral.. and can make it worse.. because now the public sector employees, who aren’t constrained by profits (so not as affected by people not buying their services) are also losing their jobs, and we go right back into that first paragraph.. they people who depend on their spending lose their jobs and so on.

      On the other hand, raising government employment and expenditures mean now you have people with money, who, in fulfilling their needs, create the demand required to make private sector go “Hey, we can expand in this area and it’s cheap right now..” Their hiring leads to more people with money, which means more things being bought, and hopefully the downward spiral stops.

      And yes, this incurs debt on the part of the government. Ideally, however, once the downward trend is stopped, tax revenues start increasing, the start getting more money back, etc. Additionally, as people get more money, that’s when government should start cutting back on what its doing and let the private sector take over. Which is pretty much what Gordon is saying Canada did. Once the private sector had recovered its footing, government services started getting cut, so our income went up as our expenditures went down, and the deficit rapidly disappeared and became a surplus.

      It’s all basic Keynes, and it works. The tough part is that while most governments are cool with the spending more part, they have a difficult time once times turn good, to start cutting back.

      Unfortunately, the CPC doesn’t seem to understand the fundamental difference between a government and a private enterprise (dependancy on profit). So they think government should ape private enterprise and will end up simply exacerbating the normal ups and downs of economic activity. Mr. Harpers promised to start spending more when he gets more, and will cut more as he gets less. This is perfectly reasonable in a private enterprise, but it’s exactly the opposite thing that a government needs to do.

    • Good point. In fact, when did the whole notion of jobs become so divorced from the notion of work?

      Jobs exist to provide services or goods. We don’t need more goods and services when we have less money to spend during a recession. In other words, demand for public services has not increased (with the possible exception of Employment Insurance case workers). So there is no reason to increase the supply. Increasing the supply produces no additional wealth, since the existing supply can meet demand.

      It’s the same old Keynesian BS that somehow increased activity is the same as increased prosperity, or the broken window fallacy that making work is making wealth.

      • Actually, we do. Employment insurance case workers, as you point out, for one. We also need more educators to get people new skill sets (because downturns typically occur due to technology shifts). We also need more public transit, both local and national as economic shifts cause people to be more likely to move. We need more support services such as social services, and publicly supported daycare.

        Sadly, during downturns we also need more legal system.. as poverty can push more people into criminal activity, so the whole gamut from beat-cop to judge and everybody who supports them we need to look at getting more of.

        On top of all that, downturns are excellent times for governments to invest in strategic infrastructure building.. you can hire people while they’re cheap, build something that will last well past the recession, and we all can use it as times get better.

        And if you had any clue what the GDP actually was, you’d know that increased activity is increased prosperity. That’s practically the definition of it.

    • Look up:

      -Paradox of Thrift (if everyone stops spending, everyone’s income falls)
      -Countercyclical government spending/automatic stabilizers/feedback loops

  3. One historical note. The mid 90′s was also when the AB gov’t slashed royalties on oil sands development (1% royalty until cap cost recovered, then 25%), and the Fed gov’t of Chretien added accelarated capital cost allowance for the sector.

    In combination with low interest rates, and a declining exchange rate (oil priced in US dollars, so good for Can producers), this encouraged investment that would have not otherwise occurred with low oil prices. And made the oil sands industry well situated when prices took off during the next decade.

    The US O&G sector is currently undergoing a boom itself now due to relatively high world prices, and improvements in technology.

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