The dangers of polite austerity

When markets fail, governments should step up, not hold back

The internet has noticed some parallels between the current moment and the US Republican response to the 1929 stock market crash and Great Depression - I’ve seen many variations on Ferris Bueller’s econ teacher telling dazed teenagers that the 1930 Smoot-Hawley tariffs were not effective in raising more revenue for the US federal government, and as a result the US fell deeper into the Great Depression.

The commonly accepted narrative on the centre-left is that those tariffs were responsible for deepening the economic crisis, but less explored is the impact of the accompanying international consensus on balancing government budgets, which was more devastating for the global economy.

South Korean economist Ha-Joon Chang explains in his book “Economics, the user’s guide”:

One influential view, propagated by neo-liberal economists, is that this large but totally manageable financial crisis was turned into a Great Depression because of the collapse in world trade caused by the `trade war', prompted by the adoption of protectionism by the US through the 1930 Smoot-Hawley Tariffs. This story does not stand up to scrutiny. The tariff increase by Smoot-Hawley was not dramatic - it raised the average US industrial tariff from 37% to 48%. Nor did it cause a massive tariff war. Except for a few economically weak countries such as Italy and Spain, trade protectionism did not increase very much following Smoot-Hawley. Most importantly, studies show that the main reason for the collapse in international trade after 1929 was not tariff increases but the downward spiral in international demand, caused by the adherence by the governments of the core capitalist economies to the doctrine of balanced budget! (Chapter 3: A brief history of capitalism. How have we got here?)

A very simple economic model has three broad categories of actors - governments, households, and businesses. All spending in the economy comes from one of these three groups, and they are all linked - if businesses cut back spending, workers make less money, and so they spend less money with local businesses and pay less tax to governments … and so on.

The key premise of Keynesian interventions is that when aggregate demand is falling (businesses and households are spending less money in the economy), the government has to step up and inject investments in order to stop the downward cycle. Keynes famously said that it didn’t matter what governments paid people to do - there would be a beneficial effect even if all the government did was pay people to dig holes and then fill them back up. But there are many investments that governments could make that would improve the long-term productivity of our economy, at the same time that they keep people working and money circulating in our communities.

After American policy makers got the economy wrong with tariffs and austerity budgets, they got something very right with The New Deal - rooted in Keynsian economics and the value of public infrastructure. It would be great if we could remember that lesson, and dismiss the naysayers that tell us the many reasons why we can’t have nice things. We can have nice things, they’re only telling us we can’t because they want to keep them for themselves.

Mark Carney didn’t come back for you

Canadians who aren’t firmly in Pierre Poilievre’s camp really want Mark Carney to be the saviour we need - socially progressive, environmentally conscious, knowledgeable and experienced in economic crisis, a staunch defender of Canada’s independence. The desire for safety and security is so deep and emotional and palpable, that a woman yelling out to Carney “Lead us, Big Daddy” at a campaign rally has inspired a song with the same name.

Carney is all of those good things, but he is also a defender of the economic status quo - a dangerous impulse to leave unchecked at this moment of economic upheaval and transition. Technical decisions can entrench economic inequality in ways that are hard to undo, and when they’re couched in progressive language they can undermine support for the real thing. There’s an opening to chart a different path in this moment, one that will foster a more equitable economy for years to come, but left to his own devices, Carney isn’t going to be the guy to do it.

Big Daddy isn’t here to save you, he’s here to save the economic status quo.

Luke Savage did a very good deep dive of Carney’s appeal and the drawbacks of his economic technocratic nature before he won the Liberal leadership race, I’m going to focus on his balanced budget promise.

The problem with Carney-ism

“Spend less, invest more”

In an interview with Rosie Barton, Mark Carney committed to “reduce spending of the government, balancing operational spending,” which he defined as ‘programs that the government runs, transfers to provinces, such as for health and education, transfers to individuals, and debt servicing’. He draws a distinction between the operational budget and the capital budget, and says he’ll run a small deficit in the capital budget.

The federal government uses accrual accounting, so the operational surplus/deficit is exactly the same as the budget surplus/deficit that you hear about on budget day, as you can see in the table below from the 2024 Public Accounts. The ‘net actuarial losses’ has to do with how public sector pensions and benefit obligations are accounted for, which can vary widely from year-to-year. The federal government has little control over this valuation, and so they pull it out to show how much of the variation from year to year is connected to actuarial changes. But it’s still definitely part of operational spending.

On April 10th, the NDP released an announcement that looked at the Parliamentary Budget Officer’s 2025 election baseline, and added the estimated cost of the Liberal “middle class tax cut” and the lost revenue from the cancelled capital gains inclusion increase. (Check out this CCPA analysis of all of the parties’ tax cut promises for more information.)

It turns out that balancing the ‘operational budget’ by 2027/28 means cutting $43 billion out of planned spending.

Mark Carney responded to the NDP press release by saying that he will ‘maintain’ transfers. Disconcertingly, he did not say he would maintain planned increases to transfers. I say that because maintaining (i.e. freezing) current operational spending is almost exactly enough to balance the budget by 2027/28.

There are four main categories of operational spending in the federal budget. The first is major transfers to provinces, territories, and municipalities, which includes health care and education transfers. The 2024 federal budget estimated that this would increase from $105.5 billion in 2024/25 to $117.7 billion in 2027/28. This includes a 5% annual planned increase to the health care transfer, which is the minimum required to meet the costs of inflation plus population growth.

Next is ‘other major transfers’ which includes the Canadian Dental Care Plan benefits, support for electric vehicle battery manufacturing, and refundable clean economy investment tax credits. This portion of the budget is expected to increase by $8 billion in the next three years.

Third, we have direct operational spending - what we usually think of as the federal public service. Mark Carney has said that he will put a cap on the federal public service to rein in government spending, but Budget 2024 already included some sizable cuts here, so it is only budgeted to increase by $1.4 billion by 2027/28.

The last category is major transfers to persons - think Old Age Security, Canada Child Benefit. Budget 2024 estimated a $20 billion increase in this category by 2027/28.

The only operational spending not included here from Carney’s definition is debt servicing, which the government has less control over adjusting once the money’s been borrowed.

The federal government would need to freeze all four categories at 2024/25 levels in order to mostly elimate the forecasted deficit of $43 billion by 2027/28.

I’m old enough to remember Paul Martin’s budgets in the 1990’s. He implemented deep cuts to health care and education transfers to provinces and territories, froze some other transfers at rates below inflation and population growth, and froze the wages of the federal public service. (I was in the naval reserves and had my wages frozen with the rest of the public service.)

Funding levels never recovered. The current crises in health care, education, and post-secondary education owe their roots to Paul Martin’s deep cuts of the 1990’s.

Maybe Carney means something different than ‘maintaining’ transfers in order to balance the operational budget. Maybe when the Liberals come out with their costed platform we’ll find out that he considers $43 billion to be a small deficit.

I hope so. Because the last thing our economy needs right now is another round of austerity.