World watching as Canada casts aside austerity and gambles on a fiscal surge

Canada has abruptly switched sides in one of the perennial political and economic battles over how to restart a sagging economy.

To put it in a way that would not please either side, it is the contest between the misers and the spendthrifts. After years of the penny-pinching approach, Canada has switched tack to become a big spender.

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And despite some very strong feelings on either side, it is not absolutely clear which is the right path to prosperity. The world will be watching.

The clash over the best way to boost a moribund economy is by no means solely a Canadian argument. Nor is it just a modern debate.

Historical debate

Countries from China and Japan, to Greece and Ireland have taken different views on the subject.

Historically, the dispute has arisen repeatedly — notably during the Great Depression, when the first response of austerity was blamed for making the problem worse. But when governments then altered strategy, new spending failed to lead to a miracle recovery.

There is plenty of evidence on both sides. As I noted back in 2010, Japan and Ireland backed opposing strategies. But the countries' circumstances are so different it is hard to declare a definitive winner. 

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China and Greece switched sides. Greece was driven by the ballot box toward bigger spending, then restrained by their stern European central bankers. China faced alternating worries, first cutting back on fears of overheating and then suddenly spurring new spending on fears of falling growth.

Canada is a special case. It's an example of a country that, following an election, consciously changed from one strategy to the other when they tossed out the Conservative government of Stephen Harper and elected the Liberals under Justin Trudeau.

"This budget is a nightmare scenario for taxpayers who will be forced to pick up the tab for today's Liberal spending spree," said Harper's interim replacement as party leader, Rona Ambrose.

Ambrose and her Conservatives still back what you might call the Irish model. During their 10 years in power, the Harper government cut taxes, both for business and for the population at large. And with revenues depleted by tax cuts, it began paring down government spending to make expenditures match income.

Austerity's intuitive appeal

The austerity argument has a lot of intuitive appeal. If your family gets into financial trouble, the wisest strategy is to hunker down, cut back on spending and get everyone out looking for work.

• The politics of austerity

Besides the analogy to family finances, another argument — once called liberal or neo-liberal, now usually known as conservative — says the best way for governments to solve economic problems is to get out of the way and let the forces of business and market economics find a solution.

As with any real-life economics, doing double-blind tests to discover the truth doesn't work. In Canada, the strategy of government austerity and business-led recovery did not have a good result, although things may have been different if had been tried at a different time.

As it was, the private-sector economy — spurred by tax breaks and directed by market forces — poured the country's wealth and human capital into a resources boom just as the boom turned to bust.

Private-sector investment in the economy began to dry up.

In Tuesday's budget speech marking the change of direction, Finance Minister Bill Morneau harked back to an earlier time.

"After the dark days of the Great Depression and the Second World War, Canadians believed the future could be brighter," he said, pointing out that post-war government spending on roads, shipping and communication systems made the economy grow and prosper.

Perhaps so, but most economists say the recovery from the Great Depression was not based on insipid attempts to boost peacetime spending, but the massive borrowing and spending boom of the global war effort itself. It was a simultaneous mixture of personal austerity and government spending on the war machine. 

Post-war comparison

It is not at all clear that the near $30-billion deficit, and the $120 billion worth of infrastructure spending promised over the coming years, large as they seem, are enough to restart the country's economic engine in a similar way.

It is also not obvious that the new strategy will have the same effect as the "Greatest Generation" returning from war to rebuild the country after some 15 years of consumer privation.

But compared to the techniques other countries have tried in attempting to push their economies back into growth, it is not so crazy.

Monetary policy has not proved itself. There are growing fears that negative interest rates create new dangers.

Reports in the foreign press — from those that noticed — are mildly supportive of the switch. Economics columnists have frequently recommended fiscal stimulus, and even cash handouts called helicopter money, to break Europe out of a cycle of deflation and negative real interest rates.

Just like the business-led austerity plan that came before, the new strategy is a living experiment with Canadians as the laboratory rats. Just as in the previous experiment, the results may depend on many outside factors beyond the current government's control.

If it works, Trudeau and his finance minister will be heralded for their genius. If it doesn't, there will be no shortage of people ready to say "I told you so."

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