Mr Cameron has been holding up the example of Canada as a good example of a country who radically cut spending in the 1990s. It is easy to take a historical precedent and give misleading impressions we can apply it in different circumstances.
A few features of Canadian deficit reduction of the 1990s (see: Good article by Marshall Auerback)
- Canada debt wasn't at crisis levels, it was half that of Italy and Belgium
- The Spending Cuts were offset by a loosening of monetary policy. Canadian interest rates were cut to maintain consumer spending (UK rates cannot be cut, only more quantitative easing.)
- The Spending cuts were also offset by a strong depreciation in the Canadian currency and a boom in exports to the US. At the time the US were growing strongly. In 1998, Canadian exports accounted for a staggering 45% of GDP.
The fall in government borrowing was offset by a rise in private and corporate borrowing.
What people forget is that in a recession government borrowing needs to rise to offset the rise in private sector saving. Focusing only on government borrowing gives a misleading impression to the indebtedness of a county. See: Principles of Borrowing which offers a similar graph for US.
Government borrowing in a recession should not be seen as 'reckless' or 'irresponsible'. The only irresponsible action is to starve the economy of spending at a time when it needs it most. It's a lesson we've trying to learn ever since the Great depression
Why UK spending Cuts would not Work like in Canada
- There is little room for monetary policy easing.
- There is little scope for further export led growth. The Pound is depreciating, but many countries are now trying to allow currency to weaken.
- Austerity in Europe is creating less growth in the Eurozone - our main trading partner.
- Household sector is still fragile, tax rises and spending cuts would lead to a fall in private sector spending.
- Lower growth will make it difficult to reduce the deficit.