The apparent success of Europe's leaders in dealing with the European economic crisis at their recent summit may mark the beginnings of a stronger fiscal union but exactly how this might be enforced is still a big question. The long term goal is to tie budgets, currencies and governments even more tightly together. However, without further political integration – an actual federal system with tiers of powers and responsibilities – there is really no way that member nations will adhere to mandated tax and spending decisions. Moreover, the transfers that would be part of such a system from “richer” to “poorer” regions could very well be even larger as a share of GDP than those in Canada’s federation as described in Stephen Gordon’s recent post.
The trials and tribulations of the European Union, its debt crisis and the Euro and the suggestion that part of the solution lies in a stronger fiscal union reminds me of the forces behind the drive for Canadian confederation in the mid-nineteenth century. Canadians are usually taught in school that major forces driving Confederation were the potential threat of territorial aggrandizement by the United States in the wake of the Civil War or the need for a larger market given Britain’s move to free trade and the end of Reciprocity with the Americans or the desire to generate the economic resources to build a railway to the west so that it could serve as an investment frontier.
One factor that receives very little mention is the fact that the prior to 1867 the colonies of British North America were heavily in debt and faced a fiscal crisis of their own. The solution to the colonial debt crisis that Confederation allowed was the creation of the federal government that was given strong revenue raising powers and assumed provincial debts and thereby stabilized the public credit. Public debt charges in 1867 already accounted for 29 percent of federal budgetary expenditure and by 1880 had only been whittled down to about 24 percent. Canada was born in debt.
Canada was created with a large debt as the provincial and local levels of government had invested heavily in transportation infrastructure – canals and railways in particular. In 1850, there were only about 66 miles of track in operation but by 1860 about 2000 miles of track had been built in eastern Canada. The total cost of building these railways in British North America up to 1867 was 145.8 million dollars the bulk of which was for the Province of Canada – Ontario and Quebec. By way of comparison, Canada’s GDP in 1870 has been estimated at about 383 million dollars.
The result was a large amount of public debt to finance this construction. Along with outright subsidies of land and cash for which governments borrowed heavily, governments also provided bond guarantees for railway companies. The government debt of the Province of Canada (Ontario & Quebec) alone grew from 18.7 million dollars in 1850 to 54.1 million dollars in 1859 – an increase of 189 percent over a mere decade. On top of it, the late 1850s ended in economic depression and railway companies went bankrupt. There was over expenditure on railways during this period – reminiscent of the tech bubble investment that was supposed to bring about the new economy in the 21st century.
Moreover, not just provincial governments got into the act. The desire for each community to be “on-track” in the new economy led to municipalities also acquiring large amounts of debt. Glazebrook’s classic history of transportation in Canada mentions how during this era little Port Hope in Ontario with a population of 4,000 incurred a debt of 740,000 dollars to invest in railway infrastructure.
Confederation was designed to fix a massive debt problem. Creation of a new political entity – the dominion government - would allow for the current debt burden to be serviced and for more credit to be obtained on foreign markets to fund the railway projects of the late 19th century – the CPR, Canadian Northern, etc…Confederation was a solution to the debt crisis but required a form of government that reduced sovereignty for the member units in order to stabilize the public credit. In the Canadian case, as acrimonious as the discussions were, the process was facilitated by the fact that the member units were all British colonies with similar institutions. Europe today despite the EU’s half century of working together more closely, is still quite diverse both economically, politically and socially.
Would a more integrated fiscal and economic union solve Europe’s debt problems, stabilize its public credit and its currency and banking systems? In the Canadian case, the total value of the Federal government’s debt in 1870 was 111 million dollars – for a debt to GDP ratio of 29 percent. By 1900, the value of Federal public debt had grown to 292 million dollars – for a debt to GDP ratio of 32 percent. Provinces and municipalities also continued to borrow and their debt increased – their finances coming to a head again during the Great Depression. The impact of Confederation on the nation’s public finances was not merely a stabilization of the public credit to deal with past debt problems but also the creation of the ability to acquire more debt. Ultimately, Canadian federalism was a creative tool of public finance. Will the Europeans manage to be just as creative?