We Need to Worry More About Canada’s Economic Growth

Published in The Globe and Mail.

Recent Canadian economic forecasts show a similar profile of modest growth this year and next.

Those predictions – from the Parliamentary Budget Office, Desjardins, Deloitte Canada, TD Economics and others – show the economy strengthening subsequently, returning the rate of unemployment to a level that is low by historical standards.

But given underlying weak productivity, falling business investment in machinery and equipment, and relentless attacks by the U.S. administration on the Canada-U.S. trade relationship, such positive forecasts are far from assured. We are dismayed that more attention is not being paid to the very fat tail of downside risks and the sharp implications for policy and private-sector planning.

A deteriorating trade relationship with the United States is a key risk for the Canadian economy. Complacency stems from the fact that around 90 per cent of Canadian exports to the U.S. continue to be tariff-free under the United States-Mexico-Canada Agreement. But the Trump administration has announced the beginning of a review of the free-trade pact.

The U.S. ambassador to Canada cites the unofficial agreements his country struck with the European Union and Britain as potential models for a new arrangement with Canada. But those agreements include base U.S. tariffs of 15 per cent and 10 per cent, respectively, plus other trade restrictions on products of particular importance to Canada. Few Canadian sectors would be able to quickly adapt production to meet the needs of domestic buyers facing a similar tariff.

Low productivity is another challenge facing our economy. Can we expect to sharply increase trade with Europe when data from the Organization for Economic Co-operation and Development show Canadian labour productivity is below that of Ireland, Norway, Luxembourg, Belgium, Switzerland, Denmark, Austria, the Netherlands, Germany, Sweden, France, Finland, Britain and Italy? Without increased investment, Canada could only compete abroad through lower wages, a weaker Canadian dollar or both. The result would be permanently lower real incomes for Canadians.

The only way Canadian firms can compete amid restricted access to foreign markets is to improve productivity through increased investment in both physical and intellectual capital. However, investment in machinery and equipment is falling – an inflation-adjusted 12-per-cent decline over the past four quarters.

The investment gap with the U.S. has become yawning; in the second quarter of this year, the C.D. Howe Institute calculated machinery and equipment investment per worker was at an annual rate of $12,800 in the United States, more than triple the Canadian figure of $4,100. Reversing this shortfall will require increased saving by households and much greater reinvestment of retained earnings by businesses.

Canadians should be more worried about their economic prospects. Instead of a brief period of tepid growth, there could be a prolonged period of weak, even zero, growth, coupled with a much higher rate of unemployment. Canada should act to address the risk of such a scenario.

A key focus must be raising the share of investment in the economy so that labour productivity is increased. That will necessitate reducing the public and private consumption share of the economy and making Canada more attractive for investment – both for Canadians and foreigners.

In the Nov. 4 budget, the federal government should cancel the billions of dollars promised in its election platform but not yet implemented. Instead, the budget should offer broad-based incentives to innovate and reinvest. Ottawa should set a more ambitious target for savings from existing federal spending, and the review should include transfers to provinces and territories as well as transfers to individuals. Spending and regulatory programs should be examined through the lens of value for money and efficiency enhancement.

In the short run, efforts to increase the investment share in the economy should reduce the share of both public and private consumption. To prevent any subsequent burden from falling disproportionately on a minority of households, policies should emphasize incentives to increase participation in the labour force, immigration that raises skill levels, and facilitating adaptation to our rapidly changing economy.

Canadians and their governments should focus on what they must do to prepare for a more difficult future than many forecasts have predicted. They should aim to mitigate downside risks and then on seize on opportunities that the changing global economy may offer. The best possible trading relationships with the United States must be secured, trade must diversity beyond the U.S., the domestic economy must be strengthened, and all these opportunities must be backed by a more productive, competitive Canadian economy driven by stronger investment.

David A. Dodge is chair of the C.D. Howe Institute’s National Council. He was formerly governor of the Bank of Canada and deputy minister of finance.

Don Drummond is a Fellow-in-Residence at the C.D. Howe Institute and the Stauffer-Dunning Fellow at Queen’s University.