December 14, 2020 5:00PM

Canada Fiscal Record Not Supportive of Keynesian Theory

Congress is debating another aid package for the states and private sector. Further aid for the states is a bad idea. Aid for small businesses makes more sense, but a better approach would be for state governments to end mandated shutdowns which are starving businesses of revenues.

Many economists are saying that more federal aid is needed to boost GDP. But, as noted here, GDP shot up in the third quarter even as government spending fell.

Canada’s experience in the 1990s also does not support the Keynesian idea that higher government spending boosts growth. Canada cut spending in the mid‐​1990s and its economy boomed.

Canada had a sharp recession in 1991, worse than the U.S. downturn at the time. Keynesians would say that Canada should have boosted spending in subsequent years to stimulate recovery. But Canadian policymakers worried that deficits were high and government debt was rising. The federal and provincial governments changed course and started cutting spending.

What was the result? The chart shows annual real GDP growth and the annual real change in total federal‐​provincial‐​local program spending. By program spending, I mean total non‐​interest government spending.

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Here is my interpretation of the chart:

  • 1992 to 1997: Decelerating, then falling, government spending coincided with a strong rebound in economic growth. Government program spending fell four years in a row (1994 to 1997) while GDP growth averaged a robust 3.3 percent annual rate during the period. Total government spending including interest fell from a peak of 52.5 percent of GDP in 1992 to 43.5 percent by 1997 (Table 52).
  • 1998 to 2008: Steady GDP growth slightly outpaced growth in program spending in this period. Total government spending fell to 38.8 percent of GDP by 2008.
  • 2009: Canada is dragged into recession by the U.S. crash, and then like the United States passed a stimulus spending package.
  • 2010 to 2019: From 2010 to 2014, Canadian governments revert to a more frugal spending path and GDP grows fairly strongly. Justin Trudeau takes office in 2015 and shifts the federal government toward higher spending. Total government spending was back up to 41.2 percent by 2019.

Federal and provincial governments have followed somewhat different paths over the years, and there are other nuances not addressed here. The important lesson for U.S. federal policymakers is that the Canadian federal government in the 1990s cut spending on defense, unemployment insurance, aid to provinces, business subsidies, and much else while pursuing microeconomic reforms such as privatization, as discussed here. The federal government ran surpluses every year from 1998 to 2008.

As the U.S. economy pulls out of recession, we have huge federal deficits and rising debt, as Canada did in the early 1990s. We should follow the same reform approach: slash spending and pursue microeconomic reforms such as privatization and deregulation.

Notes:

For the chart, government spending and interest payments are from Table 34. I deflated spending by the GDP price index, which is from Table 36–10-0223–01. Real GDP growth is from the OECD here.

Details on Canada’s economic reforms of the 1990s are here.

The Fraser Institute has a wealth of information on Canadian government spending here. I appreciate Milagros Palacios of Fraser helping with the chart data.