A Debt Interpretation of Canadian Confederation

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 21^st 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 19^th 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?

Comments

[Jim Sentance]

As an interesting addendum to this - Prince Edward Island, which likes to pretend its the birthplace of Confederation on the basis of hosting the Charlottetown Conference in 1864, initially rejected the idea of joining in, and did not become part of Canada in 1867. They did join a few years later, after - you guessed it - nearly bankrupting themselves building railroads. One of the major terms was the assumption of our debt by the feds.

[Stephen Gordon]

Great post, Livio.

[Simon van Norden]

Livio;

"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."

Two quick comments.

1) Europe has an actual federal system with tiers of powers and responsibilities. You may want to familiarize yourself with the European Parliament and the European Commission, their functioning, their responsibilities and their budgets.

2) Those transfers could "very well be even larger"....or not. As I suggested in response to Stephen's recent post, Canada's regions tend to be hit by larger asymmetric shocks in the form of commodity (esp. energy) price changes. Europe's main energy exporters are outside the eurozone. The biggest asymmetric shocks Europe have seen so far are banking crises; they've just set up a separate mechanism to deal with that. If that mechanism works (?), why is it not reasonable to think the Euro zone will need smaller fiscal transfers than Canada?

[Simon van Norden]

I always like to learn more economic history. But I'm not sure why the amalgamation of several indebted colonies into one bigger indebted colony makes them more credit-worthy. Do you know what was going on here? Did the new government have much stronger revenue-raising powers? Did confederation lump together some highly-indebted and some less-indebted colonies? Did it solve some kind of co-ordination failure?

[Kevin Milligan]

Hi Jim--funny, I had just tweeted about PEI's reluctant (and late) joining of Confederation in 1873. Here is an historian's take: http://www.umanitoba.ca/colleges/st_pauls/ccha/Back%20Issues/CCHA1961/Bolger.pdf

I laugh at the part where only 3 silent citizens were gathered to witness the reading of the proclamation. Not a popular thing at the time, this Confederation.

[Determinant]

Newfoundland had an even more troubled history with railways than PEI did. Newfoundland was hit with a banking crisis in 1895 which decimated the island's banks and led to them being taken over by Canadian banks. Newfoundland used the Canadian Dollar as its currency from then on (Newfoundland Dollar notes were actually pegged to the CAD).

Newfoundland spent a lot of money on building the Newfoundland Railway, which was completed in 1898. It never made a profit. The government financed $60 million of construction with debt; the First World War added $35 million to that figure. All payable in Canadian dollars.

By the 1920's Newfoundland faced a solvency crisis as fish prices fell. The Depression in 1929 was the last straw. Between debt payments and "relief" (as welfare was known in those days, the individual payments were pitifully small) Newfoundland was completely insolvent. After the Colonial Building Riot in 1932, Newfoundland requested a bail-out from London. An Inquiry consisting of two British commissioners and one Canadian (most of the bondholders were Canadian banks) made a survey and came to the expected conclusion: Newfoundland could have a bail-out, but in return Responsible Government (the House of Assembly) was to disband and government was placed in the hands of an unelected Commission. Democracy was terminated in Newfoundland for the next 16 years.

It should be noted that Newfoundland achieved Dominion status in 1910, at the same time and on the same terms as South Africa and New Zealand. It is the only instance in modern times of a democratically elected legislature with substantial sovereignty voting itself out of existence and ending representative democracy entirely.

http://www.heritage.nf.ca/law/collapse_responsible_gov.html

Fast-forward to 1948. Newfoundland is making its third and final application to join Confederation. The last attempt in 1895 fell apart over debt considerations, the Federal government customarily assumed most or all provincial debt when a new province was admitted, partly for solvency reasons, partly because the primary revenue source was tariffs which would be taken over by the federal government, and partly because it was an attractive inducement. Newfoundland had no income tax but it did have steep tariffs. Confederation would leave it without this revenue source and income taxes would take time to implement.

Canada decided to be generous with Newfoundland, 90% of the debt would be assumed by Ottawa ($65 million) and Newfoundland could keep its surplus which had accumulated because of the war boom. ($29 million cumulative surplus booked). Newfoundland entered Confederation on balance debt-free.

http://www.heritage.nf.ca/law/ottawa.html

It also negotiated the standard income tax rental agreement that Ottawa had with the provinces, it received the usual subsidies paid to the Maritime provinces since 1867 and it got a transitional grant for 12 years. The Newfoundland Public Service was divided 50/50 too, depending on whether the department handled a federal or provincial matter under the BNA Act. The transitional grant morphed in to Equalization in the 1950's.

You can't talk about Newfoundland and Confederation without talking about debt.

[Frances Woolley]

Livio - really interesting post

[Jacques René Giguère]

Simon van Norden: a bigger polity can smooth its revenue over a larger area bypassing local cycles. It can more credibly defend its border as its shifts resources from former-external-now-internal-borders to the still external ones, etc.
Confederation was wildly unpopular everywhere. About as much (probably lower) than the EU Commission is. Like the EU, it was mostly a policy elite racket.It was clear to everyone, debt notwhistanding, that the winner would be the new province of Ontario. Essentially, so it was.
It is ironic that the ROC elite insisted on referendum in QC in the last decade, as they bitterly refused to hold one in 1867. And ask anyone in NL what they think of their own ( democracy not being in the voting but the counting...)

Happy Canada Day (and for Québécois both La Confédération and la Journée du déménagement (Moving Day), as all residential leases begin by default on July 1st and so the night of June 30th is a festival of the moving van.) End of the popular culture note.

[Determinant]

On reflection, the "debt burden" was not that British North American governments were insolvent, it's that they had reached their fiscal limit and still had more to do. Further, the really big projects would be inter-colonial or inter-provincial and co-ordinating the route policies of two or more colonies and their contribution in cash or land was problematic.

Further, in 1854 the US had signed free-trade deals (Reciprocity Treaties*) with the New Brunswick, Nova Scotia and the Province of Canada. This combined with the Canadian boom resulting from the Civil War led to the early 1860's being remembered as "Golden Years". But in anger over British sympathy for the Confederacy and the construction of Confederate commerce raiders in Britain, the US terminated these treaties. This plus peace led to a business slump in Canada.

The poster-child for this problem was the Intercolonial Railway from Halifax to Montreal. This was partially complete and was intended to be a defence work as well as a commercial venture. The British used it to reinforce the garrison in Upper Canada in 1862. But getting money for construction was problematic and so the railway was incomplete.

The BNA Act not only instituted a new federal government, it gave that government complete authority over railways and further made completion of the Intercolonial Railway a condition of Confederation. The line was completed in 1872 and was always government-owned.

*Reciprocity is a better term than Free Trade; it means co-ordinated tariffs for revenue only, instead of protective or barrier tariffs.

[Determinant]

Confederation was wildly unpopular everywhere. About as much (probably lower) than the EU Commission is. Like the EU, it was mostly a policy elite racket.It was clear to everyone, debt notwhistanding, that the winner would be the new province of Ontario. Essentially, so it was.

I quibble with that. Confederation was wildly unpopular in Nova Scotia and a close-run thing in New Brunswick. New Brunswick was the only colony to have a Confederation Election, two of them in fact, in 1866. Sir John A. Macdonald sent thousands of dollars in bribes from the Government of the Province of Canada to aid the Confederation Party in New Brunswick. The Confederation Party won. Bribery was common in every election everywhere in Canada in that time. It wasn't really stamped out until the 1920's.

In the Province of Canada, Confederation was popular because it was a divorce. The united Province of Canada with its political gridlock between Upper and Lower Canada was to be disbanded and turned into Ontario and Quebec. Confederation was the medicine that allowed Upper and Lower Canada to get the divorce that each so badly wanted but that London wouldn't allow otherwise. That and Macdonald explicitly courted the Quebec Roman Catholic bishops. Quebec didn't "sign a pact" in 1867, Quebec didn't exist as a government. It was recreated in 1867, the same as Ontario was, even through both provinces have tried very hard to forget that fact.

The Newfoundland referendum wasn't the subject of vote fraud, it was "supported" in the same way as New Brunswick in 1866: money, unconditionally and in copious amounts. When Joey Smallwood came to Ottawa in 1947 he was taken aside by Mackenzie-King's chief of staff and handed a list of wealthy Liberal donors in Toronto and Montreal who would bankroll the Confederation Party in Newfoundland. The cartoons for the Confederate Newspaper, which was popular as much for its cartoon quality as for its message, were produced in secret in Toronto by the Globe & Mail's editorial cartoonist and mailed to St. John's daily. It was also populist, the Confederation Party drew support from outside the Avalon Peninsula in the outports while the Anti-Confederates were based on the traditional Fish Barons in St. John's, the traditional Newfoundland elite.

In the same spirit the "Yes" rally in 1995 blithely ignored the Quebec rules, nobody cares about fundraising rules when it comes to a Confederation election. Yes, rules were broken. So what? It was nothing new.

Counting down to Jacques' retort in 5, 4, 3....

[Livio Di Matteo]

Simon:
1.The EU has a federal character but is closer to a confederacy than a federation. While there are EU wide expenditures and policies, a parliament, a commission bureaucracy and a single currency, the operations are still largely governed by a treaties and negotiations between sovereign states rather than units that are both independent and coordinate. As well, I'm not sure Brussels has the power to levy EU wide taxes on individuals to fund EU wide spending programs.
2. The federal government got the power to levy taxes of any type whatsoever whereas the provinces only got "direct taxes". As well, the main revenue source was customs duties and the federal government got that. The federal government in Canada is perceived to have at the outset gotten the more important revenue sources. Over time, the distinction between direct and indirect taxes has disappeared and the provinces are now equivalent to the federal government in their s to revenue sources (aside from custom duties/tariffs which are now a minor revenue)
Ah well, back to a rather disappointing soccer game.

[Angelo Melino]

Debt also played an important role in forging the US federal union. After the revolutionary war, most Americans viewed themselves as citizens of their state, not "America". Against the opposition of a group that came to call itself the "Republicans", Alexander Hamilton, and the other Federalists, lobbied for the creation of a strong unified country. The Federalists pushed for the adoption of a new constitution and the transfer of some power from states to the federal governments Just as it did later in Canada, debt played a key role in the creation of a stronger US federal government. Some states had accumulated large debts to fund their contributions to the war, and had poor prospects to pay it off. The main source of government revenues were custom duties, but not all states could take equal advantage of it (and there was fear that those that could, like New York, would impose a tax on goods that entered its ports destined for other states). Alexander Hamilton helped create a strong central government in the US by having the federal government assume the existing debts of all the states, along with the revenue stream that came from custom duties.

[Nick Rowe]

Really good post Livio!

My question was the same as Simon's: "But I'm not sure why the amalgamation of several indebted colonies into one bigger indebted colony makes them more credit-worthy."

I think Jacques' answer is plausible. If you add two or more provinces together in a federal portfolio, diversification reduces the risk, unless the two provinces' tax revenues are perfectly correlated. But note one possible difference here with the current Eurozone crisis: Canada at the time was on the gold standard, and didn't have a central bank as such. So in a liquidity crisis, as opposed to a solvency crisis, I'm not sure how much federation would have helped. It maybe depends on whether the Bank of Montreal was acting as a de facto central bank?? In other words, I think there's a monetary policy angle here as well as a fiscal angle. (But I don't know enough Canadian monetary history to figure it out.)

[Nick Rowe]

Oh, and was Jacques' answer to Simon's question also referring to the idea that any single province that raised taxes would risk losing population and tax base to lower tax provinces? So the taxing power of the whole is greater than the sum of the parts? (If that's not what Jacques was saying, I will say it.)

[Determinant]

That kind of tax competition was immaterial in 1867. It didn't become an issue until income tax was raised to serious levels in 1917 (it existed before then, but not in all provinces, and was light where it did).

But Livio's post has a bit of a problem:

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.

Percentage of government expenditures. Government revenues, primarily from tariffs and property taxes were small. Social services consisted of elementary schools and very few high schools which most students didn't bother to attend. Then there were the courts. That was it. Governments were not expected to do anything more. Borrowing was the accepted way to fit big demands onto the long-term government revenue stream.

Tax competition was irrelevant because the colonies were so disparate. Nova Scotia and New Brunswick had much stronger trade ties to the US than to the Province of Canada. We united partly because we were all British, or at least not Americans.

The real problem with railways was that an incomplete railway which which crossed borders was a greater drain on the government that had the debt for the complete section. A railway had to be complete to have real value. Railways were thus very susceptible to cascade failure and a single government for the entire line was very desirable to maximize a railway's value. It solves the debt problem by focusing on the revenue side.

[website]

By tying governments and currencies even more closely together will only exacerbate the problem! Think about it, it may solve our problems in the short run, but when we hit the roof again, we will all be impacted as a whole, the so-called global economy would drown all at the same time! Outlying countries will be affected, everyone will be affected.

In order to fix this economical crisis we have to change the rules and foundation by which it is governed, aka usary, loans, credit, etc!

[Jacques René Giguère]

Nick:"So the taxing power of the whole is greater than the sum of the parts? (If that's not what Jacques was saying, I will say it.)"
I'll say it. Unification creates a monopoly. It will be exploited, hopefully to provide the public goods that competition won't provide.
Though: would 60 independant states and provinces creates more small wars between themselves or will they be forced into peace by the cost of modern armaments? If we go back to swords, Nevada can battle Utah.Not if Utah retains the F-!6 squadron at Hill AFB. Which they can't afford on their own. lots of interesting possible equilibriums...

[Jacques René Giguère]

Determinant:"In the Province of Canada, Confederation was popular because it was a divorce. The united ...."
Canada was generous to NL. Perfectly true.Marrying for the money is not the best way to happiness.
There was no QC or ON to sign a pact. Yes as for institutions. Not so as for public opinion ( or sentiment in the day's parlance). Apart from the divorce, public sentiment disapproved of what they thought was a bad deal, even if it got us out of another very bad deal. RC bishops were courted, a good sign to everyone that something was fishy. The Church was respected as amean of cultural preservation and as a provider of services. Their political leanings were always treated with contempt. A friend of mine had one of his ancestor excommunicated for shouting in a church :" Talk to us about the goodness of God and stop talking about the goodness of the English!."

Back to the bunker. Arizona, here I come!

[Determinant]

You're arguing against evidence, Jacques. Confederation was very popular in what would be Ontario and English-speaking Montreal, mildly popular in French-speaking Quebec, mildly popular in New Brunswick (the only one of the original 4 provinces to have an election on the topic, which came out in favour) and very unpopular in Nova Scotia. Nova Scotia was brought around by 1870 and French Canada's politicians never asked for Lower Canada to go it completely alone. They did get "Property & Civil Rights" which was to protect the Civil Code and also got provincial control of education.

There is no record of any of the Quebec Confederation fathers being against the BNA Act and no anti-Confederation slate of MP's or MPP's were returned in Quebec thereafter. Quebec did not part ways with the Conservatives until the death of Louis Riel in 1885. You are arguing the classic Rouge line, which was the minority opinion.

In pre-Quiet Revolution Quebec, dealing with the Roman Catholic Church was how politicians, especially federal politicians, got things done in Quebec. Laurier would later perfect the classic "bridge" campaign of being a Real Britisher in English Canada and being a Real French Catholic in Quebec. The advent of television and French-immersion in English Canada put an end to that sort of widely disconnected campaign. You're coming at the question with modern eyes. No politician wanted to risk having the Church against their proposal.

The same went for Ontario in fact. Macdonald made sure to convince Rev. Egerton Ryerson, leader of the Wesleyan Methodists (now part of the United Church) and brought him and the Methodists alongside to Confederation just as he did Quebec. You needn't feel alone in the intersection of church and politics.

I cite as evidence Richard Gwynne's recent biography of Macdonald as well as "Turning Points" by Ray Argyle, a chronicle of historic elections. What became Quebec was quite quiet and did not return an anti-Confederation slate in the 1867 election, Nova Scotia did. Nova Scotia was the reluctant sister and drama-queen of Confederation, not Quebec. Macdonald put an end to the "Repeal" movement by co-opting Joseph Howe and giving Nova Scotia the same financial terms that New Brunswick got and which their delegation hadn't got for them: a complete debt assumption by the federal government plus subsidies in perpetuity to replace lost tariff revenue.

If Quebec Separatists have perfected the art of being against Confederation, they must concede the origin of the idea lies not with them, but with Nova Scotia.