Monday, June 14, 2010

Canada's Spending Cuts and the UK

It seems the whole of Europe has developed a mania for good old austerity, and deficit cutting. (One could almost forget we have 2.5 million unemployed, it seems the only economic objective in Conservative Britain is reducing the budget deficit.)

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.
An Example of A Fall in Government Borrowing Leading to A Rise In Private Borrowing.
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.

No comments: