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From a Canadian official who did it: Cutting deficit is no easy task

By Richard Galant, CNN
Paul Martin, former Canadian prime minister and finance minister, presided over elimination of the nation's deficit in the 1990s.
Paul Martin, former Canadian prime minister and finance minister, presided over elimination of the nation's deficit in the 1990s.
  • In 1993, Canada was staggering under a rapidly rising debt burden
  • Then-Finance Minister Paul Martin began a multiyear program to reduce spending
  • Martin says it took consultation and an early record of success to make it work
  • He says Canada was able to wipe out deficit, cut taxes, reinvest in social services

(CNN) -- When Paul Martin became finance minister of Canada in 1993, the government was spending itself into a deep hole. Its spiraling debt was prompting observers to compare it to a Third World country. Martin unveiled budgets that steeply cut the $42 billion deficit and eliminated it in four years without long-term damage to the economy.

The example of Canada has been cited and debated as governments in developed countries around the world are looking for ways to cut spending and reduce the size of their debts. Britain has embarked on sweeping spending cuts with an eye toward Canada as a model. In the United States, the midterm elections focused attention on the size of the budget deficit.

Martin, a Liberal Party member who later became prime minister, says lessons can be learned from his nation's experience, though he says many differences exist between Canada's situation in the 1990s and the U.S. economy today.

For one thing, the U.S. is now recovering from the most serious recession in decades. He accepts the view of many economists that the U.S. economy is too fragile for deep spending cuts now, but believes there should be progress on a medium-term plan to cut the deficit.

Martin spoke to CNN earlier this month; here is an edited transcript:

CNN: Can you describe the state of Canada's finances when you became minister of finance in 1993?

Paul Martin: We had the worst deficit, the worst debt-to-GDP ratio of any of the G-7 countries, with the exception of Italy. In fact, financial commentators were making frequent references to us as a Third World country. We were at that point where the inexorable effect of increasing compound interest was pushing us closer and closer to the debt wall.

In fact, we were in a debt spiral and some 45 percent and rising of our national debt was held in foreign hands. At the same time, we had an unfunded liability in the Canada pension plan, which is our national pension plan, which was greater than our national debt. And we were under some pressure to deregulate our banking system to follow what was going on in other countries such as the United States, the United Kingdom and continental Europe.

CNN: And what did you do?

The inexorable effect of increasing compound interest was pushing us closer and closer to the debt wall.
--Paul Martin

Martin: Well, we did a number of things. Instead of loosening or deregulating our banking system, we tightened up, with the net result that some 15 years later when the banking crisis hit -- the one we are now going through -- our banks came through it with flying colors.

Second, we got together with the provinces ... and we got our national pension plan into a situation where it is now actuarially probably the most sound of any national pension plan. In fact, it is actuarially sound for the next 75 years, which is essentially in actuarial terms, virtually an eternity.

In terms of our deficit, there are two points that I should make. The first is that our countries are very different. The parliamentary system is quite different than the presidential/congressional system, in that a government certainly in our situation at that time, we had a majority, is able to take the kind of steps in a reasonably expeditious manner as compared to perhaps the United States, where that is a little bit more difficult.

CNN: In essence you are contrasting a parliamentary system to a checks-and-balances American system, where it's intentionally harder to get legislation through?

Martin: Yes, I think the way I would put it is that the founders of the United States wanted to have a system of checks and balances, and they succeeded I suspect better than they thought. Now, the second thing is that unlike the current financial system where most of the Western world is suffering from the aftermath of the recession, at the time that we acted our economy was not very strong, but we were not in recession, and the rest of the world was doing somewhat better.

CNN: How did you manage to bring down the deficit?

Martin: The first thing is that it was very important for us as a government to bring the [leaders of the] public service on side. Unlike the U.S. where your public service changes from government to government to government, our public service stays in position and they have huge institutional memory and they are a very important part of any government dealing with the deficit, where in fact there are going to be large numbers of [government] employees who are going to be losing their jobs. And in fact, close to 20 percent were cut.

A year before we did that budget [the 1995 budget that called for deep cuts], we did an extensive consultation across the country, town halls, publicly televised meetings. ... Previous consultation processes had involved isolating the various interest groups and meeting with them often behind closed doors, occasionally publicly. So you'd for instance meet with the unions alone, and then you'd meet with business alone or you'd meet with health care officials alone or you'd meet with educators alone.

What we did was to insist that the meetings would be public and that at those meetings representatives of all of the interest groups [be there]. ... We wanted the Canadian people to understand that these were not easy decisions and that there were no perfect answers and the tradeoffs had to be made.

We wanted the Canadian people to understand that these were not easy decisions and that there were no perfect answers.
--Paul Martin

We had made a commitment that we were going to halve the deficit in three years. ... We ended up eliminating it in four years, just under four years. The first thing that I did was to meet with my officials and go through department-by-department spending. The first question that we would ask is: What is it we have to preserve in this spending if the economy is to be strong and if the government's mandate is to be fulfilled?

The second question is then how much can we cut? And we went through this line by line. The next day, I met with the ministers of the various departments and I gave them their targets, and they were very tough. ... Over 50 percent of the expenditures of our department of industry were eliminated. Over 35 to 40 percent of our department of transport expenditures were eliminated. So I mean we cut very deeply.

I met with the individual ministers, and I gave them their targets, and you can understand that those were greeted with astonishment, which is a polite way of putting it. But, we did do one other thing. ...

The government created a Cabinet committee, under a new minister, called the minister for public service renewal. Cabinet ministers who felt that they were being cut unfairly or unjustly had the right to appeal those cuts to this Cabinet committee. That committee could in fact change the targets, could amend the targets ... subject however, to one condition: that whatever mitigation or break was given one minister, it would have to be made up from another minister. In other words, while the individual targets were appealable, the government's bottom line was not.

While the pressures on us from the market were very great, our main motivation was really not to keep the bankers happy. ... What had been happening is that ineffective attempts to deal with the deficit over the previous decade had really led to a bleeding away of our social programs and our main message, and in fact our main motivation was to protect those social programs, and the only way that we could protect those social programs was in fact to deal with the deficit as deeply and as quickly as we possibly could because if we had simply let this thing continue to drift on, we would have lost them.

Most people are not economists, they're not bankers; they are living their daily lives, and the cuts that you're making affect their daily lives. And so they have to understand that the cuts that are being made are not being made to satisfy anybody else but them, and in fact to deal with this deficit so that their children didn't have to deal with the burden.

CNN: Why is that important?

Martin: People will accept that hurt if they feel that you are going to succeed; in other words, where you will lose public support is if you say we're doing this to reduce the deficit or eliminate the deficit and you start missing your deficit targets so that people begin to feel that what you're doing is in vain, then you will lose that support.

What we did is we projected long-term targets, but we also projected annual deficit targets. ...

What happened was that at the end of the first year we beat our deficit targets -- now it wasn't that difficult a target, but it was the first time in many, many years that a Canadian government had actually beaten a deficit target of any kind. This occurred roughly about the same time that the cuts were beginning to be felt, but Canadians saw "well they've beaten that first target," and so that gave them some confidence.

It was the first time in many, many years that a Canadian government had actually beaten a deficit target of any kind.
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The second year we had a very tough target, very difficult to meet and we beat it as well and at that point the public support for what we were doing became tremendous, huge, because Canadians saw that the sacrifices that were being asked of them were not in vain, but they were leading to where we had promised.

We began then to pay down debt and our debt to GDP ratio dropped from the worst of the G-7 to the best of the G-7. We brought it down ultimately below 30 percent, and we were able at that point to start cutting taxes. I brought in the largest tax cuts in Canadian history, and we reinvested back into the areas where we had cut.

Health care, as an example, we were able to... [enact] the largest health care budget in Canadian history. We put huge amounts of money back into education. None of this would have been possible if we hadn't eliminated the deficit and at the same time -- and I think this is really important -- it's not sufficient to only eliminate a deficit, you've got to start to build up surpluses.

Every two years, we went through a global financial crisis of some kind and you've got such interdependent economies as we have now, those crises are going to occur and it isn't sufficient to simply have a deficit-free balance sheet. You've got to build up surpluses that will allow you to ride through the kinds of volatility that today's global economy presents.

CNN: What was the impact on the Canadian economy of reducing government spending so dramatically?

Martin: Initially, it has an effect, a negative effect. ... As soon as people began to see that we were not only serious but we were going to reduce the deficit as we said, and then as soon as they saw that we were actually going to eliminate it, confidence just took right off and we came through.

CNN: What was the impact on the unemployment rate?

Martin: Our unemployment rate dropped. Again, it didn't happen overnight, but it dropped very steadily. It dropped very steadily, to the point where it was virtually a record low. And in fact at one point, which is something that had never happened before, this is long before the current crisis, our unemployment rate actually dropped below the United States.

CNN: In the United States, and I'm sure that you've read a lot of this commentary, the argument from some economists is that this is precisely the worst time to cut government spending, it's the Keynesian argument that you must increase government spending in order to speed up the recovery from the Great Recession. What do you make of it?

Martin: Well I have a lot of sympathy for it. What we did is certainly worthwhile studying, but our two countries are very different, and the states of our economy at the time were very different. I do not believe, just in today's comparison, for instance what's going on in the United Kingdom is necessarily the right lesson for the United States to follow.

I am one of these people who believe that TARP prevented us from going into a depression. I think that the actions that have been taken by the U.S. government are the right actions. I think that what they are going to have to do very soon is to start showing us a medium-term deficit reduction plan.

CNN: What would your advice be on how to achieve that?

Martin: I think that clearly you've got to talk about that, you have to basically talk to the American people, and make sure that they understand it, and understand what has to be done and where you're going to do it. Very clearly, there has to be cooperation from Congress under your system.

CNN: How does cutting the deficit actually contribute to growth?

Martin: Because of the anticipation [by businesses], that in fact their taxes aren't going to go up and that they can invest without that fear. ... It's essentially confidence. The economy works on the basis of confidence, and then if business is confident, they will invest. If they will invest, jobs are created. If jobs are created, consumers buy and in most of our economies, of course domestic consumer spending is the most important component of domestic GNP growth or GDP growth.

So, it's confidence of business, but it's also confidence of consumers. If they see government acting decisively on something as worrisome and as burdensome as a deficit then that will increase.

But there are two big differences between our two situations. Number one is when we acted; the rest of the world was in a reasonable position in terms of economic growth, not just the United States. Today, you've got austerity budgets all over the place, and consequently it's a very different atmosphere out there.

CNN: What would your advice to President Obama be, in terms of this issue right now?

Martin: I think that the president is on the right track, and I just think that he's got to obviously stay with it. I think that the rest of the world is very much hoping that the administration and the Congress will be able to work together. I mean I think that this is important for the United States, but it's important for the rest of us as well.

Let's face it, I'm sure everybody really accepts that the growth projections in the United States are far weaker than any of us would want to see. I think that you have to work at dealing with the deficit, but at the same time you have to make sure that you are doing that in the context of steadily increasing economic growth. My opinion from the outside is that this can't be done by either the administration or Congress acting alone. They have to work together.