Strategy

Outlook 2011: The year of cutbacks

Governments worldwide are slashing spending, pensions and jobs. How the war on deficits affects you.

(For the rest of the Outlook 2011 special report, click here.)

In New York City, where the firefighters are revered as the “bravest” and police officers are dubbed the “finest,” uniformed workers have a reputation for dogged determination and fierce civic pride. Which explains why recent allegations against the city’s sanitation workers — known as “New York’s Strongest” — left residents shaken. Following the late December blizzard that dumped nearly two feet of snow on the city and for days left roads impassable, the sluggish removal was initially blamed on cutbacks in the sanitation department. But a more insidious possibility soon emerged. According to councilman Dan Halloran, several workers confessed that they had been told to “take their time” to punish the mayor for implementing further cuts. Though the top brass denied the allegations, the claims were enough to prompt federal prosecutors and a city watchdog to launch probes. “We’re going to do an investigation to make sure that it didn’t happen,” said Mayor Michael Bloomberg. “It would be an outrage if it took place, but I just don’t know.”

Either way, the controversy reflects the bitter feelings emerging as cash-strapped cities, states and countries cut spending. The axe has fallen hard in many industrialized nations, as governments from Greece to the U.K. to California slash jobs, wages and benefits in a desperate bid to curb crippling deficits and calm worried lenders. As public anger mounts, world leaders continue to trumpet the virtues of austerity. Canada, which famously eliminated its deficit in the mid-1990s under Finance Minister Paul Martin, is being upheld as a shining example. In June, U.K. Chancellor of the Exchequer George Osborne readied skeptical Britons for the deepest hack to public spending since the Second World War by painting an almost utopian picture of the Canadian experience. “They engaged the public in the choices that had to be made, and they took the whole country with them,” he said of Martin and his team. Everything will be OK, he suggested, if everyone just pulls together and follows the Canadian way.

But politicians who believe they can replicate the Canadian experience in the current climate are “in a state of denial — total political and public denial,” according to Don Drummond, who was an assistant deputy finance minister under Martin. Canada was able to eliminate its deficit in three years without plunging into recession, he says, because it was largely alone in pursuing austerity, which meant a big lift from a strong global economy. “We had an element of luck,” says Drummond, who went on to become chief economist of TD Bank Financial Group. “I don’t think any of those conditions will apply this time around, so this is going to be the good old-fashioned way of blood, sweat and tears.” Martin, who has become a sought-after sage on the international speaker’s circuit, isn’t promising a panacea, either. “I’ve made it abundantly clear in my public remarks, and I certainly did privately, that [when a government makes] the decision to take the deficit on, there are no guarantees,” he told Canadian Business.

Many experts believe that widespread Canadian-style austerity will send the global economy, which is still in a state of fragile recovery, careening over the edge. (Drummond and Martin are not among them.) New York Times columnist Paul Krugman goes so far as to raise the spectre of the Depression-era financial policies that led to the collapse of the Weimar Republic — and the Second World War. “Will it really be 1937 all over again?” he asks. “I don’t know.”

Already, austerity measures have touched off palpable unrest. In December, as Greek policy-makers approved yet another round of budget cuts — tough legislation that caps salaries at state-owned companies, cuts many state salaries by 10% and diminishes collective bargaining power — some 20,000 protestors jammed the streets in the country’s seventh general strike that year. Demonstrators lit Dumpsters on fire and threw stones at a member of parliament. Meanwhile, in the U.K., protestors went wild in London after parliament approved a nearly threefold hike in university tuition fees, part of Prime Minister David Cameron’s austerity measures, which took a 19% bite out of ministerial budgets. As angry hordes smashed windows and lit fires, a group encircled a conspicuous Rolls-Royce, which was conveying Prince Charles and his wife, Camilla, to a show. They hurled bottles, paint and fists and screamed, “Off with their heads!”

While the kind of austerity that’s likely coming in Canada may be minor in comparison, it won’t be wine and roses, either. The cuts in the mid-1990s shrank the public service by more than 30,000, rolled back unemployment benefits and downloaded much of the federal deficit to the provinces and municipalities — leaving less fat to trim this time around. In Ontario, the provincial belt-tightening that followed the federal cuts has been blamed for everything from larger class sizes to the tainted-water disaster in Walkerton. Meanwhile, in Alberta, cutbacks in federal health care preceded a number of hospital closures, including three in Calgary. “We’re going to feel the pinch,” says Armine Yalnizyan, the senior economist at the Canadian Centre for Policy Alternatives, who predicts another wave of job losses.

Even if the doomsday predictions about worldwide cost-cutting are overblown, the effect isn’t likely to be the kind of unified “Canadian” response that Osborne envisioned. The decision to try to rein in deficits now is a calculated risk. For a host of reasons, governments the world over have chosen to cut spending, not as a virtue, but as what they believe to be the less severe of two painful options. Correct though they may be, one thing is certain: the Age of Austerity will hurt.

When it comes to trends in fiscal crisis intervention, Merriam-Webster’s annual Words of the Year list is a surprising source of insight. In 2008, as governments struggled to save the world’s financial system from collapse, the Springfield, Mass.???based dictionary named “bailout” its No. 1 word of the year. Just two years later, however, the tide had dramatically turned. In December, the company, which chooses the year’s top words based on out-of-the-ordinary spikes in interest, announced that “austerity” clinched the top spot in 2010. According to the editors, the 14th-century noun, defined as “the quality or state of being austere” and “enforced or extreme economy,” was the subject of some 250,000 online queries.

Indeed, government stimulus has fallen sharply out of fashion. With the exception of the U.S., which recently extended Bush-era tax cuts and unemployment benefits under what has been dubbed “Stimulus II,” the push for deeply indebted countries to clean up their balance sheets has taken centre stage. It’s easy to see why. While debts in many industrialized nations have long been out of control, in the eurozone, deficits have been growing faster than in any downturn in the past 35 years. Despite regulations that prohibit annual deficits from exceeding 3% of GDP, in 2009, the deficits in Ireland, Greece, Spain and the U.K. were more than three times that much.

But while all that red ink set up the necessary conditions, it took the threat of a sovereign debt crisis and the rise of small-c conservatism to generate what John Monks, general secretary of the European Trade Union Confederation, has described as a “stampede towards austerity.” As the fiscal disasters in Greece and Ireland unfolded, and bond yields began drifting perilously upward, making it tougher to finance government borrowing, the eurozone rushed to calm nervous lenders. The IMF-EU rescue packages these countries accepted came with strict orders to cut public spending. Meantime, member states that could still call their own shots began imposing (or at least loudly promising) sweeping austerity — a desperate bid to keep the contagion at bay.

This kind of logic is particularly evident in the U.K., says Glen Hodgson, senior vice-president and chief economist of the Conference Board of Canada. “They put in place a very, very tough budget because???they were terrified of ending up as the next Ireland or Greece.” The confidence issue is also what prompted Martin to take on Canada’s deficit in the 1990s. “Everybody thought that it was only going to take one more financial crisis, and we would be past the tipping point,” he told Canadian Business. “That contagion effect was my biggest fear.”

But the barbarians-at-the-gate theory doesn’t fully explain why countries like the U.K. are pursuing public spending cuts with such gusto. Unlike in Greece and Ireland, British austerity is a choice. “It’s some kind of morality play, like ???We have sinned and now we must suffer to pay for those sins.’ But we don’t have to,” says Stephen Gordon, a macroeconomist an Laval University. “It’s self-imposed.” In Gordon’s view, Britain is not yet facing significant pressure from bondholders, making the austerity drive very much about the politics of the day. The same is true in the U.S., where Republicans promised austerity upon seizing control of the House of Representatives. As Gary Hufbauer of the Washington, D.C.???based Peterson Institute for International Economics, explains, “The public has basically revolted against further fiscal deficits spending.”

All of which let governments slice far more deeply than they might otherwise dare.

Just over a month before the recent riots in England, Martin was in London to address the Confederation of British Industry. In an interview with The Independent, which dubbed him “Godfather of the cuts,” Martin said he was proud of what he accomplished as finance minister, but confessed that in beating back the deficit, “there were some areas where I think we may have cut too much, and as soon as we eliminated the deficit, I immediately began to repair it.” The admission highlights a fact that those who trumpet Canada’s success story often leave out. “It was painful in Canada. There’s no question about it,” recalls Chris Ragan, an associate professor of economic policy at McGill University who agrees with the current austerity push. “A lot of the [current] shortages in the health-care sector date from that time.”

So how much pain is about to be inflicted? If the Age of Austerity is badly managed, says Hodgson, “it could last for generations.” The tenor of the protests that rocked Greece in mid-December should give some indication of the severity of the reform that’s underway there. In Ireland, meanwhile, the government recently approved its toughest budget on record. The ???6-billion chop to public spending will come at the expense of cherished social programs: the child benefit took a 10% hit, public-sector pay was cut by up to 15% and social welfare trimmed by 4%.

Meanwhile, Britons are getting a sense of what’s involved in Cameron’s “Big Society,” his grandiose name for a bid to shift responsibilities from government to citizens. The austerity measures on the table include raising the retirement age to 66 from 65 by 2020; slashing university funding by as much as 40%; and clawing back one-fifth of funding to police. These changes are already having real implications: by mid-December, when the public sector had shed just 33,000 of the estimated half-million jobs on the chopping block, unemployment levels approached 8%, a six-month high.

In the United States, Congress has largely favoured stimulus over austerity (new House Speaker John Boehner vowed to change this in his maiden speech), but a growing number of cash-strapped states and cities is stoking the same kind of sovereign debt fears that are rippling through Europe. Prohibited from running a deficit, and dogged by sinking credit ratings, these jurisdictions are cutting corners in some shocking places. Arizona has stopped funding specific kinds of organ transplants. Hawaii, meanwhile, recently dropped Fridays from its school week.

Even in Canada, a relative shining star — or, as William Robson, president and CEO of the C.D. Howe Institute, puts it, “one of the least ugly in the beauty contest” — public spending cuts are coming. Finance Minister Jim Flaherty, who ran a projected $56-billion federal deficit last year, recently softened his stance on stimulus along with his deadline to get back to balance, but even little trims hurt. In Quebec, for instance, public low-income housing agencies estimate that a recent cut in funding slashed their repair budgets by 30%. Likewise, immigration support groups across Canada are preparing to adjust their programs following a $53-million hack in federal dollars. (Federal health-care transfers, which have been increasing by 6% a year, will surely be examined closely when they come up for review in 2014.)

But the real pinch, say experts, will come from the provinces, of which only three are on track to a balanced budget this year. Ontario Conservative leader Tim Hudak is campaigning on a platform of cuts. If elected in October, he says, “We would have a sunset review process for every agency, board, commission and ministry program.” Drummond concurs: “Every one of these governments is going to have to look under the rock of every single program and figure out whether they need it.”

In the aftermath of the Great Recession, austerity rhetoric has become a hallmark of responsible government. But economists concede that there are many unknowns. As Gary Hufbauer asserts, the combination of fiscal tightening and monetary loosening that many countries are pursuing is something “we haven’t seen in modern history.” “I am a supporter of the policy,” he says, “though I realize that we’re in uncharted territory, and I certainly see it could [possibly] blow up.” It’s helpful to remember, however, that calculated risk is often the best policy-makers can do. After all, though the Canadian deficit-slaying story is celebrated today, says Drummond, “we didn’t know in 1995 that it was going to have a happy ending.”

For all the bluster, many heads of state have yet to explain how they’ll turn talk into action. As the IMF observed in its November Fiscal Monitor: “In most countries, concrete adjustment measures have not yet been enacted, and in many, they need to be specified in more detail.” And as tough as it is to put an austerity budget in place, it’s even tougher to stick with it in the long term. Lasting spending freezes aren’t easy for politicians to stomach. “You will do nothing [but] manage the books, be a bean-counter,” says Drummond. “That’s not what you ran for, and it tends to be a very difficult thing to do.” His proof: in the Canadian postwar period, only three jurisdictions froze their spending for more than five years.

The more pressing concern, of course, is people, and how much of a squeeze they can take. Because, as the recent uproar in Europe shows, supporting austerity in theory is quite a different matter than staying behind it in practice. “There’s no way Ireland is going to sit through 10 years of austerity,” says Mark Blyth, an international political economist at Brown University. “These governments eventually fall. It’s called democracy.”