Let's Let Canada Be Our Economic Mentor


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 ofChevron (NYS: CVX) , Royal Dutch Shell (NYS: RDS.B) , and even China's Sinopec (NYS: 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 (NYS: RBC) -- of which I must admit to being an alumnus -- and Toronto Dominion Bank (NYS: 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.

At the time thisarticle was published Fool contributorDavid Lee Smithdoesn't own shares in any of the companies named in this article.Motley Fool newsletter serviceshave recommended buying shares of Chevron. The Motley Fool has adisclosure policy. We Fools may not all hold the same opinions, but we all believe thatconsidering a diverse range of insightsmakes us better investors. Try any of our Foolish newsletter servicesfree for 30 days.

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