Let's Let Canada Be Our Economic Mentor

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As you prepared for the long weekend on Friday, The Wall Street Journal added to concerns about a worldwide economic hibernation. You've certainly been saturated by news of difficulties in Greece and Spain. But the paper's lead article touched upon weakening in such bastions of recent stability as China, India, and Brazil.

Even that's not especially news for those who noted the comparatively feeble April economic numbers from Beijing. So perhaps the most amazing concept in the Journal's piece was the contention that "a steady U.S. economy could bolster the rest of the world." Perhaps a steady -- or even growing -- U.S. economy could benefit much of the planet. But with our nation's employment trends continuing to be languid, and a bulging deficit rapidly propelling our deficit toward a sobering $16 trillion, it's tough to envision America's economy booming anytime soon. So the notion of our country serving as an engine for anything, let alone the rest of the world, is somewhat unfathomable.

An example to imitate
Indeed, in my rarely tentative opinion, it's high time for the U.S. to look to our friends to the north in the land of maple leaves for a proven approach to once again becoming a formidable financial force. 

I recognize that much like Australia, Canada has benefited from its abundance of natural resources. That obviously includes its tar sands. For years now those deposits have kept the likes of Chevron (NYSE: CVX  ) , Royal Dutch Shell (NYSE: RDS-B  ) , and even China's Sinopec (NYSE: SNP  ) busy seeing to the production of the thick, gooey substance and turning it into usable crude oil. Beyond that, they've provided the country with a substantial amount of economic security.

Until 1995, however, our northern friends were mired amid economic weakness that resulted in a penchant for borrowing that might have rendered as amateurish our own determined and expanding efforts to hit up creditors. Beginning in the 1960s and through the first half of the '70s, Canada's debt expanded at between 5% and 10% annually. But that clearly was just a warm up. In the dozen years following 1975, it exploded by about 20% per year.

And the country's government spending more than kept pace. From 15% of the nation's gross domestic product in 1965, public outlays reached 23% by 1993. The next year, with the nation's total debt tickling $500 billion, the Journal called Canada an "honorary member of the Third World."

Faulty planning
As has been the case in the U.S. in recent years, there were several factors propelling Canadian spending and borrowing. Clearly culpable were the runaway entitlement programs, including the Canada Pension Plan (CPP), a program not terribly dissimilar from our own Social Security system. Much like Social Security, the assumptions on which the program had been based, including the extent of the country's expected population growth and its likely income expansion, were at odds with ultimate reality.

Further, spending was also running amok in the provinces. From 1963 to 1993, provincial outlays more than doubled, while their related debt tripled.  

Time for big-time changes
By 1995 Canadians -- unlike many Americans today -- had had enough. Two years earlier, a left-of-center Liberal Party, led by Prime Minister Jean Chretien, had been voted into office. But it was Finance Minister Paul Martin's 1995 budget that began the turnaround. Spending cuts, rather than tax increases, were the primary levers utilized in the process. Early reductions centered on civil service, wage freezes, and the relocation of some programs from Ottawa to the provinces.

As a result, overall spending plummeted by 8.8% in just two years, and in 1996, the federal government accounted for just 13.3% of GDP. And as a potential paradigm of an elixir for the U.S. today, employment in the public sector was cut by 14%. Perhaps most importantly, by 2007, the national debt had been chopped about in half.

Based upon a steady and ineluctable strengthening, an all-important series of tax cuts was undertaken -- this, you'll recall, by a Liberal government. For example, there was a pair of reductions in the capital gains rate. And the federal corporate levy was slashed from 28% to 15%, far below the globe-high rate that currently characterizes our own approach.

Big economic muscles
Thanks in large part to these strong measures, Canada entered the recent global recession in the strongest position among the G-7 nations, obviously including the U.S. and Germany. Realistically, however, with the aforementioned new economic pullback affecting many of the world's economies, Canada clearly isn't immune to a slowdown of its own.

Nevertheless, with the world's soundest banking system, led by Royal Bank of Canada (NYSE: RBC  ) -- of which I must admit to being an alumnus -- and Toronto Dominion Bank (NYSE: TD  ) , the country should be positioned to right itself more quickly than the rest of us. The real lesson, though, is that Canada bit the proverbial bullet and undertook a program of strong economic medication based on spending cuts and reduced tax rates. It worked superbly. Almost certainly, we in the U.S. should use it as something of a Canadian beacon.

In Part 2 of this article, I'll discuss how a newly revived and resource-rich Canada today fits into the world's economy, most significantly vis-a-vis the U.S. and China.

This discussion is hardly meant to imply that the U.S. is without its own compelling bank stocks -- I strongly suggest that you obtain a copy of The Motley Fool's report, "The Stocks Only the Smartest Investors Are Buying." It's absolutely free.

Fool contributor David Lee Smith doesn't own shares in any of the companies named in this article. Motley Fool newsletter services have recommended buying shares of Chevron. The Motley Fool has a disclosure policy. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days.

Read/Post Comments (6) | Recommend This Article (12)

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  • Report this Comment On June 01, 2012, at 1:08 PM, ksgill wrote:

    Yes, but Canada apparently implemented spending cuts and reduced tax rates when the economy was strong. It is U.S., with the economy weak, these same policies would be misguided.

  • Report this Comment On June 01, 2012, at 9:26 PM, zinser wrote:

    I think you're missing a key point in your article. I would argue it was a combination of tax increases and spending cuts.

    The election of the liberals in 1994 was due largely to the introduction of the very unpopular goods and services tax in 1991.

    The GST has raised billions in additional revenue every year since its introduction. 40 billion in 2008-2009 as a recent example. It would have been much harder to put the federal government house in order without this additional revenue.

    I recall the GST being pushed as a temporary measure until the federal deficit was eliminated but it managed to stick around even when that happened. Still as far as taxes go at least it's easy to see, understand and can be easily adjusted as economic circumstances dictate.

    To just look at spending cuts is seeing one half of the equation that lead our decent economic performance during the recent global slowdown.

  • Report this Comment On June 04, 2012, at 1:27 AM, matthewluke wrote:

    As zinser mentioned:

    It wasn't spending cuts, rather than tax increases. It was spending cuts AND tax increases. There were, though, a lot more spending cuts than tax increases. Maybe two dollars in spending cuts for every dollar of tax increases (don't quote me on that number; pulling that out of you know where).

    I'm not thrilled about the possibility of tax increases, but if you presented me with option of two dollars of spending cuts for every dollar of tax increases, I'd gladly jump at that. I'd prefer it if the morons in Washington never got us to the point where any tax increases were necessary, but it is what it is.

  • Report this Comment On June 04, 2012, at 5:02 AM, mhonarvarthe2nd wrote:

    It's not that simple.

    Any Canadian would tell you that it was simply the feds transfering expenses to the Provinces.

    Most of that spending was through transfers from the Federal government to the Provincial government.

    In 1995, the formula was changed and the Provinces got less from the Feds. The national debt might have lowered...but the Provincial debt hasn't (maybe not Alberta due to oil).

  • Report this Comment On June 04, 2012, at 6:25 AM, devoish wrote:

    <<As has been the case in the U.S. in recent years, there were several factors propelling Canadian spending and borrowing. Clearly culpable were the runaway entitlement programs, including the Canada Pension Plan (CPP), a program not terribly dissimilar from our own Social Security system. Much like Social Security, the assumptions on which the program had been based, including the extent of the country's expected population growth and its likely income expansion, were at odds with ultimate reality.>>

    Borrowing caused by lowering taxes is unaffordable, and always will be a tool to enslave.

    The past months articles and comments concerning the Facebook IPOo explains very clearly why we need SSI and healthcare in the USA.

    Conservatives used to be the people who thought Government programs should be paid for. Now those people are called Liberals.

    Best wishes,


  • Report this Comment On June 04, 2012, at 5:33 PM, CMFSoloFool wrote:

    Canada underwent an amazing turnaround, and despite Americans needling Canadians as socialists and criticizing their social programs, the Canadians made the tough decisions, implemented the changes swiftly, and enjoyed a very rapid recovery. Subsequently, when the US crisis hit in 2007/2008, Canada hummed along just fine and has successfully avoided the debacle, while the US is still floundering in it.

    To the point above about timing and economy, let's face it; there is never a good time to do it. You can find any excuse you like to justify why now is not a good time for it. But all you're doing is making it worse. Let's stop putting off the pain.

    To the point about raising taxes as well as cuts, I agree, increase revenue if only temporarily to get to a healthy revenue stream, provided you implement a system of cuts at a rate of 2 or 3 dollars cut for every extra dollar of revenue. A federal GST is a pretty good way to do it, it is unbiased and without loopholes so it gets everyone contributing proportionally. I'm sure someone will argue that it hits that group more than the other, but you could analyze it to death and you still will never get to an agreement, so JUST DO IT!

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