Focus
March 08, 2024 | 13:32
Canadian Growth: Time for a Rethink
Economics
Economics
Economics
Fixed Income Strategy
Economics
Economics
Economics
Economics
Economics
Economics
Economics
Economics
Fixed Income Strategy
Economics
Economics
Economics
Economics
Economics
Canadian Growth: Time for a RethinkIt’s an open secret that Canadian GDP is heading in reverse on a per capita basis. While the short-term cyclical story has been one of some modest resiliency, partly courtesy of a perky U.S. economy, the broad macro figures have also been flattered by the strongest population growth in decades. Indeed, it would be an unmitigated disaster if the economy was unable to expand at least a little bit when the adult population was growing in excess of 3% y/y. Stacked up against that reality, the 1% GDP growth of the past year is in fact quite meager. This is starkly portrayed in Chart 1, a now infamous gauge of Canada’s deep underperformance relative to the U.S. economy, which has only truly emerged in the past decade. |
|
True, the U.S. may be a tough comparison, given it has had one of the best recoveries from the pandemic, and it has been juiced by a very aggressive—and perhaps ill-advised—loosening of fiscal policy. But even compared with Australia, an economy much more akin to Canada’s and which also saw a small sag in per capita GDP last year, the comparison is far from flattering: Australia has grown 6% faster on a per person basis than Canada in just the past four years, and 15% faster since 2000 (Chart 2). The over-riding point is that, even with a small bounce in Q4, Canadian productivity is in a prolonged slump, and GDP per person is no higher now than it was at the end of 2014, nine long years ago. This woeful performance is now well known. The question is what do we do about a problem like measly growth? It just so happens that former Finance Minister Bill Morneau tasked an Advisory Council on Economic Growth to consider this very issue, and the Council delivered its final report on December 1, 2017 [1]. At just over six years ago, it’s still fairly fresh, albeit rudely interrupted by a pandemic. So, to avoid reinventing the wheel, it’s well worth reviewing its major findings. The report fretted that real GDP growth was only going to average 1.5% over the next 50 years, based on historical productivity trends of 1.1% per year, and GDP per person could ease to “just” 0.8% growth on average over the same period (versus 1.9% in the prior 50 years). It would be churlish to say in hindsight “we wish”. |
|
Not satisfied with the prospect of sub-1% growth per person, the Council offered a wide variety of recommendations, some of which remain eminently reasonable (example: a targeted review of our tax system). As a brief reminder, the major proposals are summarized in Table 1 (end of article), but we’ll focus on the headliners: Create an Infrastructure Bank (CIB) to boost such spending, become a top-tier foreign direct investment destination, increase annual permanent immigration and qualify more international students, support skills training, raise workforce participation, and strengthen business investment. Ottawa seized on some of the suggestions nearly immediately—aggressively so on the immigration file—made some partial steps on others, and have let some slip; a mixed response overall. |
The CIB has been up and running for more than six years, and is still finding its way, with outstanding loans of $11.6 billion at end-2023. The on-the-ground reality is that infrastructure spending overall has firmed slightly in recent years, but it’s almost exactly in line with its 20-year average as a share of GDP (Chart 3). Overall, nothing has changed significantly on this front, albeit with some very modest improvement. In contrast, the situation in FDI remains weak. Inflows to Canada last year were $60 billion, right in line with the average of the past five years, but also little different from levels prevailing prior to 2017. Meantime, Canadian FDI outflows were nearly twice as large last year at $113 billion, leaving a sizable net FDI outflow of $53 billion (Chart 4). That’s not a record high, but after decades of rough balance, FDI is now consistently in a net outflow position of nearly 2% of GDP. And, notably, even portfolio investment flows dropped into a rare deficit in 2023, driven by record net selling of Canadian equities by non-resident investors. Thus, Canada recorded a rare trifecta in 2023 with deficits in FDI, portfolio flows, and the current account, for only the second time in the past 40 years. The major policy measure to spur capital spending was arguably the accelerated capital cost allowance in the fall fiscal statement in 2018. Suffice it to say that Canada is still awaiting a private sector investment boom. Real outlays on equipment and structures were lower in Q4 of last year than at the end of 2017, and even below levels prevailing as far back as 2008. A steep decline in spending in the oil & gas sector is a big factor, but no other sector has stepped in to fill the void. Spending on machinery & equipment has been flat on balance for nearly 20 years in real terms, and is now just 40% of the level of spending on residential structures in nominal terms (Chart 5). From 1965 to 2005, spending on M&E was higher than on housing. Given that all the focus is now on accelerating homebuilding, we’re unlikely to ever see M&E above housing outlays again. The picture on increasing workforce participation has been mixed. The overall rate has actually dropped from just over 66% in 2017 to just above 65% now. But much of this can be attributed to the relentless demographic force of a wave of Baby Boomers reaching retirement age. The part rate for those aged 15-64 has risen by roughly a point from 79% in 2017 to around 80% now. One of the specific goals of the Council was to boost the part rate of those over the age 55; instead, that group has seen a dip from just above 38% to just below 37%. An area of success over this period has been the participation rate for women aged 25 to 44; it rose 3 points to above 85%, helped by the focus on affordable child care. Note that the recommendations were generally careful not to push for big new bureaucracies, or large new government-funded programs. Yet, the reality is that one of the fastest growing sectors in terms of jobs has been public administration. Public sector payrolls have risen by 190,000 (or more than 17%) in just the six years since the report was published, with nearly half of those jobs in the federal government alone (a rise of more than 30%). As a share of overall payroll employment, public administration is now 7.2%, the highest of this century apart from the early pandemic distortion (Chart 6). The rising share of public sector employment is likely doing no favours for Canada’s weak productivity performance. The Advisory Council had aimed its recommendations at lifting output per person, with an eye on offsetting a looming decline in labour force participation in the coming years. In fact, the opposite has happened since 2017—productivity has essentially stalled out (growing just 0.2% annually since then), while hours worked have jumped amid the surge in population to an average annual growth rate of 1.3% (Chart 7). Ironically, while the Council fretted about Canada’s potentially weak GDP growth rate of 1.5% over the next 50 years, the economy has in fact grown at precisely a 1.5% annualized pace since their report was published in late 2017. |
|
Bottom Line: Canada’s economy is mired in a long-term growth funk, which increasingly looks structural in nature. The most recent significant study on strengthening the long-term growth outlook has so far proven to be a damp squib. Simply, we need a serious rethink on proposals to lift productivity and growth. Given that Canada is plagued by weak capital spending and persistent direct investment outflows, we can conclude that at the very least competitive-crushing tax hikes should be considered a non-starter. And, if higher taxes are bad for investment and productivity, unpredictable taxes are likely even worse. |
|
[1] The Path to Prosperity: Resetting Canada’s Growth Trajectory. https://www.budget.canada.ca/aceg-ccce/pdf/ideas-into-action-eng.pdf [^] |