8 September 2015

Free Market Success Stories #1: The Canadian Century


The second largest country on the planet was in a bad shape when Paul Martin, minister of finance in the newly elected left-liberal government, took office in 1993. The Canadian government was running a deficit of close to 7 percent of GDP, and the following year gross government debt exceeded 100 percent of GDP. The generous Canadian welfare system provided substantial benefits to its citizens, but it came at the cost of high taxes and tended to weaken both incentives to work and entrepreneurship. Martin realised that real change was needed to get the country back on track. So he cut welfare and business subsidies drastically.

David Herle, adviser to Paul Martin at the time, has described in the Financial Times the difficulties of introducing the Canadian reforms of the early 1990s. According to Herle, one of the rare allies that the minister of finance had in the cabinet was the minister of agriculture, Ralph Goodale. Their friendship took a turn for the worse when Goodale, who was raised on the Canadian prairie, strongly opposed Martin’s abolition of the so-called ‘Crow Rate’ – a system of transport subsidies for wheat. “Try as he might”, Herle writes, “[Goodale] could not persuade him to reconsider”.

The agricultural minister was not alone in protesting the slimming of expenditure. Large segments of the Canadian liberal party resented the reforms, as did organisations and companies whose entitlements were affected. The drastic market reforms were a tough medicine to swallow. The cuts were wide-ranging, aimed at everything from defence to regional aid, business subsidies, public transportation, and unemployment insurance. However, after two years, public expenditure was at last under control.

According to Herle, one reason why the liberals in Canada could implement such far-reaching reforms was that the party leadership invited business leaders, trade unions and civil society groups to discussions regarding the need for cuts and tax hikes. “By forcing every interest group to consider the others’ views the government bolstered compromise. No lobby could get all it wanted”, Herle writes, “the pain would be shared”. Even Goodale and the prairie farmers that stood behind him could thus be persuaded of the need for a new social contract, where reliance on public handouts was reduced across the board.

This strategy succeeded in moving the nation towards what can be described as a new social contract. In the short run, these changes seemed to threaten the economic interests of several interest groups, businesses and families. And yet, the Canadian Liberal party won a second term in 1997. The party campaigned on the promise to continue to cut the federal deficit, thereby creating a budget surplus which would allow tax cuts as well as repayment of Canada’s national debt. After yet another term of reform-oriented policies, the liberals managed to win the elections again in 2000. The Canadian Liberal party shifted from describing the growth-oriented reforms as an emergency response to a crisis, to instead promoting long lasting reforms as a way to create a better society. Making a case for the desirability of change proved to be a recipe for success.

In fact, Jean Chrétin, the prime minister who launched the first set of reforms together with his minister of finance, Paul Martin, remained in power for more than ten years. In 2003, Chrétin lost a power struggle to Martin, who at the end of the year became the new Liberal prime minister. In a speech at the Liberal leadership convention the same year, Martin explained that his goal was to continue on the path of reform:

“We have to build a 21st century economy in Canada for Canadians. We succeeded in the last 10 years because we did not deviate from our course – balanced budgets, a continually dropping debt ratio, lower taxes. We must stay on that course. […] We must be a government committed to accountability. A government that treats taxpayers’ money like it is your money. Because it is. The fact is, all of this should be a given. And let me assure you, it will be.”

There is a natural, and healthy, tendency among voters to replace the governing party from time to time. Nonetheless, in 2004 Martin and his Canadian liberal party again won the election. A conservative government took over the reins in 2006, and continued on the same path of market-oriented reforms. It proved a successful strategy also for the conservatives, as they have since been re-elected twice since. It remains to be seen who wins the new election, to be held on the 19th of October. So far, the likelihood of conservative Prime Minister Stephen Harper being re-elected is deemed by the betting markets to be slightly more likely than a win for New Democratic Party leader Thomas Mulcair. Although the opposition does want to reverse some of the conservative tax cuts, Mulcair is also running on the promise to reduce the tax rate for small businesses from 11 to 9 percent.

Hopefully, the long-term commitment to market reforms from both liberal and conservative governments since the early 1990s will continue. The work- and business-friendly policies have reduced welfare dependency, despite the global financial crises, and made Canada a hot-spot for innovative businesses. In addition, an abundance of talent is today attracted to Canada by high incomes, job opportunities created on a free labour market and low taxes.

Wilfred Laurier, the seventh Prime Minister of Canada who was in office from 1896 to 1911, predicted that while “[t]he 19th century was the century of the United States. I think we can claim that it is Canada that shall fill the 20th century.” As Forbes has opined, Laurier was right, but maybe “a man 100 years before his time”. The country, which for long was seen as the colder, more leftist and less business-friendly cousin of the US, has today according to the Index of Economic Freedom the 5th freest economy on the planet, ahead of both the US (12th position) and the UK (13th position). It is one of the best countries in the world to start and run a business in, and has a high level of human developmentThe Legatum Prosperity Index concludes that Canada combines a strong economy with individual liberty. Perhaps not surprisingly, the country has grown steadily since the 2008 crises.

Recently, the country’s economy has experienced a slide – following recent reductions in economic freedom according to the Index of Economic Freedom. To get back on track, Canada should return to the successful policies initiated by Paul Martin. If the course Canada began to follow during the end of the 20th century continues, the country might very well outshine her southern neighbour in the 21th century.

Dr. Nima Sanandaji is a research fellow at CPS, and together with professor Stefan Fölster the author of Renaissance for Reforms (Timbro and IEA). The book can be purchased from the IEA.