Anyone for Deficits?

In the late fall of 2008, the Harper government was nearly replaced by a Liberal-NDP coalition with Bloc Québécois support. This coalition, essentially without precedent in our national politics, was noteworthy in itself. But equally remarkable was that the coalition organized itself according to the position that the federal government should incur a stimulative fiscal deficit to address a rapidly declining economy. Coalition leaders argued that Jim Flaherty’s economic and fiscal statement did not respond to Canada’s economic reality and that the government did not deserve the confidence of Parliament. The government was saved by the governor general’s decision to grant the prime minister a prorogation of the House of Commons, and when Parliament reconvened, Flaherty introduced what he referred to as a stimulative budget that projected deficits worth a total of $64 billion over the next two years.

This was a startling turnaround. After years of running from deficits, federal political parties started running to them. The Liberal government had eliminated fiscal deficits in the late 1990s, and Canada’s record of fiscal surpluses over the next decade was singular among the G7 countries. This fiscal record was accompanied by adherence to the principle of balanced budgets, on which Canadian politics and policy was based. As recently as October, Harper had stated emphatically that “we’re not going into deficit” and “we have every reason to believe Canada will stay out of recession if Canada doesn’t start raising taxes and spending itself into deficit.” Yet by early December the balanced budget principle had already eroded significantly.

While the degree of change was perhaps not as pronounced in most other countries, fiscal deficits became the order of the day elsewhere as well. In the United States, President Barack Obama committed to a two-year package worth at least US$775 billion to stimulate economic recovery even before his inauguration and in the House of Representatives the Democrats posted a two-year US$819 billion stimulus bill, on top of the estimated US$1.2 trillion 2009 deficit bequeathed by George W. Bush. European Union member states agreed to a stimulative response to the economic crisis. Clearly, something was afoot. How can we understand the sudden return of deficit finance?

A Quick History of Deficit Finance in Canada

Balanced budgets have been a Canadian norm. As the Canadian economist Scott Gordon expressed in 1966, before the Keynesian revolution the grave consequences of going into the red “could be felt in the Anglo-Saxon bone marrow.” Despite this attitude, fiscal deficits hold a distinguished place in Canadian history and have been called upon as a way to achieve the goals of an activist state. Deficit finance has been used for three purposes: to build a new country, to fight world wars and to stabilize the economy.

Deficits and debt built Canada. The objective of building a national economy swept aside doubts about the wisdom of borrowing because the transportation infrastructure (originally canals, then railways) needed to exploit Canada’s natural resources was expensive and could not be privately funded. From before Baldwin and Lafontaine’s responsible government in 1848 to Confederation in 1867 to Sir John A. Macdonald’s National Policy in 1879 and beyond, Canadian governments ran nation-building deficits. By 1866, in fact, debt interest payments amounted to 29 percent of colonial spending, with more borrowing needed to finish the job. Confederation was in no small measure about deficit finance and the need to create a more creditworthy borrower—Canada.

During both world wars, the federal government used borrowing as a key method for financing Canada’s participation. In part as a reaction to the World War One approach of borrowing now and paying later, World War Two was funded on a so-called pay-as-you-go basis. Nonetheless, by the end of that war, the national debt exceeded the annual gross national product, a level not seen before or since in Canada. The scale of the Second World War required significantly more planning, coordination and central direction than had previously been asked of capitalist liberal democracies. As a result, the modern Canadian state was built.

This helped make possible Keynesian stabilization, the third main justification for Canadian deficits. As Robert Campbell writes regarding the reception of work of the great British economist, John Maynard Keynes, “the term ‘Keynesianism’ is normally taken to imply the countercyclical use of fiscal and monetary tools to even out the business cycle and perpetuate high rates of employment.” During lows in the business cycle, the government increases demand by pumping money, sometimes deficit-financed dollars, into the economy to keep employment high. When employment goes above sustainable levels, government drains money from the economy, including by running surpluses, to reduce demand and pay down debt accumulated during economic downturns. There are two purposeful ways to create deficits: increase government spending and reduce taxes. The spending option works best in a severe downturn such as the one Canada is now experiencing; handing money back to individuals through tax cuts at such a time carries no guarantee that they will spend it.

Keynesianism presupposes an activist state, one in which the government has the policy autonomy to pursue high employment, including through social policy and deficits, even if Bay Street and Wall Street—financial capital—do not like it. On the Keynesian formulation, social programs such as employment insurance—which automatically injects funds into the economy when times are bad and removes money when the economy improves—become not only a matter of justice, but also of good countercyclical economics. In Canada, across the Keynesian era, finance ministers J.L. Ilsley in 1946 and Edgar Benson in 1971 vindicated social programs on the grounds of both social equity and maintaining demand.

The Death of Keynesian Deficit Finance

Canada adopted Keynesianism in the 1940s, and the Keynesian era lasted until the mid 1970s. With the oil price shocks, stagflation (high unemployment together with high inflation), reduced productivity, Nixon’s removal of the American dollar from the gold standard and overall economic decline, the Keynesian “consensus” began to unravel in Canada and elsewhere. Canadian fiscal deficits, which over the previous 30 years had been intermittent, became persistent rather than countercyclical and continued every year for over two decades.

While deficits persisted until the late 1990s, over time the activist Keynesian state was replaced by the disciplinary neoliberal state. Neoliberalism has two targets in its sights: one, the demands from society for higher wages and government support, which it sees both as costs and as inflationary and, two, the policy autonomy of the state itself. Canadian neoliberalism was implemented, particularly during the Mulroney regime, through key policies such as the Canada-United States Free Trade Agreement and then the North American Free Trade Agreement, as well as the Bank of Canada’s price stability policy. By vesting authority in an independent central bank and international trade agreements that are at arm’s length from control by elected governments, this economic “constitution” made it more difficult for the state to politicize and regulate the economy. ((See Stephen Clarkson (1993), “Constitutionalizing the Canadian-American Relationship,” in Canada under Free Trade, edited by Duncan Cameron and Mel Watkins (Toronto: James Lorimer), pages 280–82.)) Since according to the neoliberal view the activist state was the economic problem, the disciplinary state should improve economic performance by releasing the market from state interference.

In this new order, deficit finance had no obvious place. As neoliberalism became dominant in Canada and also the U.S., deficits became a symbol for an overextended and ineffective state disconnected from the interests of average citizens. In Canada, 36 percent of the money raised from taxpayers by Ottawa was going to service the national debt. The activist state was discredited. By the time Finance Minister Paul Martin called a halt, the country had racked up some $550 billion in debt. Martin put Canadians on belt-tightening notice in 1995 when he proudly introduced absolute spending cuts that he properly described as “by far the largest set of actions in any Canadian budget since postwar demobilization.” The Chrétien-Martin elimination of the deficit completed the implementation of Canadian neoliberalism. The Keynesian justification for deficit finance disappeared entirely from federal budgeting.

The Resurrection of Deficit Finance—and the Activist State

The process of change from one dominant order to another is long. The key event that set off the Great Depression was the stock market crash of 1929, but not until the mid to late 1940s did the activist Keynesian state become primary. Similarly, while the 1973 oil price shock was the beginning of the end of Canada’s Keynesian era, the disciplinary neoliberal state only became entrenched in the 1990s. So, too, with neoliberalism’s decline and the ascent of its replacement. The erosion of the balanced budget norm and the return of deficit finance is an important moment in the long process by which a new order is replacing neoliberal dominance. ((On the fall of neoliberal “globalism,” see John Ralston Saul (2005), The Collapse of Globalism and the Reinvention of the World (Toronto: Viking Canada), especially pages 157–70.))

Why has deficit finance returned to legitimacy so suddenly? In technical terms, while depression may or may not materialize from the current crisis, as the Nobel Prize–winning economist Paul Krugman recently wrote about the American situation, “we are already, however, well into the realm of what I call depression economics. By that I mean a state of affairs like that of the 1930s in which the usual tools of economic policy—above all, the Federal Reserve’s ability to pump up the economy by cutting interest rates—have lost all traction.” Monetary policy has reached its stimulative limits—interest rates in Canada and other countries are at or near zero. If more stimulus is required—and this is the balance of opinion—Keynesian deficit spending has both a historical track record and a developed theoretical basis.

But the fact that a technically sound policy response exists does not explain why governments or political parties might adopt it. The fundamental reason deficit finance is making a comeback is that deregulatory neoliberal policy and its disciplinary state have been discredited by their association with the current economic crisis and their inability to address the problem. High-profile events like the subprime mortgage crisis and the fall of Lehman Brothers cement this association. At the same time, the crisis is relegitimizing an activist state, one that acts to improve economic performance and employment and to assist people in the short run, in their time of need. In contrast to the 1990s, deficits are perceived as being in the interest of a significant range of actors. Stakeholders—for example, the auto industry—and the public expect government both to provide short-term assistance and to address the economic crisis, including through deficit spending. Regarding public support for deficits, in mid January pollster Peter Donolo said: “It’s been a total and complete turnaround in public opinion on this issue … In one year, people have been totally shaken on this.”

The Liberal-NDP coalition was built on the argument that the Harper government was not sufficiently activist in its initial statement on the economy and the premise that Canadians would support a more responsive policy alternative. In his presidential campaign, as the American economy was seemingly getting worse by the day, Barack Obama adopted increasingly populist rhetoric in favour of an activist response to the subprime meltdown, apparently calculating that this was a stronger position than opponent John McCain’s mantra that the fundamentals of the economy were strong. Minority government in Canada and the election in the United States increased the sensitivity of each political system to the crisis. Both McCain and Harper were forced to adjust their anti-activist positions to retain political viability, although in McCain’s case it obviously was not enough.

Of course, the devil is in the technical details, and the details are being contested. Opponents of the activist state are fighting a rearguard action to direct that activism to their own ends and to disable it in the future. For example, a spokesman for the Canadian Taxpayers Federation said that his organization would “make the case for a balanced budget and for personal and business tax relief.” In the United States, representative Dan Burton argued that “free enterprise, less government and lower taxes is the way to solve this problem.” But as the activist Keynesian response to the crisis currently has the upper hand, for now these actors are on the defensive.

Debates about deficit finance are, at their core, debates about the state’s role in the economy. The return of the activist state, resurrected by crisis, is bringing with it deficit finance, and the resulting deficits are a tool facilitating that activism. To the extent these new 2009 deficits have a countercyclical purpose and effect—that is, to the extent they are constructed on stimulative government spending directed at maintaining and increasing employment—they can reasonably be characterized as Keynesian. But it is possible that something quite different will arise. Deficits do not have to be about stabilization, and contemporary deficit finance may turn out to go well beyond this traditional Keynesian objective. Crisis, after all, is an opportunity in the hands of visionary leaders and a threat in the hands of weak or cynical ones. Perhaps the activist state in the 21st century will turn out to be the green state that leads the way to a sustainable renewable energy future; perhaps it will be the kleptocratic state that hands public money to powerful friends. The return of deficit finance helps us to see clearly that the role of the state in capitalist liberal democracies is being contested anew.