Government policies are making Canada’s struggling economy even worse, writes Philip Cross in the Financial Post.
By Philip Cross, Sept. 1, 2016
Statistics Canada reported on Wednesday that second-quarter GDP fell 0.4 per cent nationally, which is not particularly alarming in and of itself since all of the drop was due to the May wildfires in the Fort McMurray area. Already, the Macdonald-Laurier Institute leading indicator shows the underlying trend of the economy righted itself in June and July, auguring a recovery in the second half of the year. However, this is no reason to be sanguine: Growth rates are likely to prove uninspiring, as the North American economy remains stuck in the slow lane. Meanwhile, our governments’ monetary and fiscal prescriptions are proving ineffective, and possibly dangerously counterproductive.
More worrisome than tepid overall growth is the source of the weakness. Business investment and exports remain a drag on growth. The investment slump is especially noteworthy for its implications for long-term productivity growth. While much of Canada’s slump can be attributed to plunging oil prices, that does not explain the U.S. slack. Furthermore, Canada’s expected upturn in manufacturing output and investment hasn’t materialized, despite the boost from lower energy prices and the lower dollar.
Not all of Canada’s economic luck has been bad. While wildfires set back growth, Canada’s lumber and auto industries benefited from one-time factors. Our lumber industry is booming, as U.S. restrictions on our softwood exports expired, while a new agreement was supposed to be negotiated. With those talks floundering, the U.S. is likely to impose new restrictions in the near term, adding further to the cross-border trade friction begun after the Obama administration blocked Canada’s Keystone XL pipeline. Ontario’s auto industry has also grown rapidly over the past year after the retooling of some plants. However, auto sales in the U.S. appear to be past their peak, clouding the outlook for auto production on top of our steadily eroding share of North American auto assemblies as new plants migrate south. Outside of autos, manufacturing in Ontario has slumped across the board.
The lacklustre performance of Canada’s economy mirrors that of the U.S., where GDP rose only 1.2 per cent in the past four quarters. Business investment in the U.S. has fallen for three straight quarters while exports have retreated in three of the last four. Overall, both of these key sectors have shrunk by just over one per cent in the past year (for the Trump crowd, imports have risen only 0.4 per cent, so import penetration has played almost no role in the slowdown).
Business investment has been the missing piece in the economic growth jigsaw for most of the major G7 nations since the recession hit in 2008. Canada had been the one exception, thanks to our once-booming oil industry, giving us the fastest post-2009 recovery in the G7. After oil prices collapsed, Canada joined the crowded ranks of countries with weak investment.
It is difficult to see a sustained upturn in growth without a boost from business investment, and that does not appear to be in the offing. The legendary economist Gary Becker blamed persistently slow investment growth in the U.S. after 2008 on the raft of new regulations brought in by the Obama administration on everything from housing to banking to energy and the environment. Regulation also has hampered investment in Canada. In the west, approval for pipelines and gas terminals keep getting delayed, while the explosion of regulations in Ontario over the past decade, on top of its soaring cost of energy, has been accompanied by businesses’ reluctance to invest and commit to growth.
Slower business investment has insidious effects on the economy. Not only does it weaken growth in the short term, but it inhibits the growth of productivity needed to boost our long-term potential. In turn, persistently weak investment and productivity growth has implications for the conduct of macroeconomic policy. In its annual report, the Bank for International Settlements (which operates as the central bank for monetary authorities around the world) highlighted how governments have reached the limits of the stimulus possible from monetary and fiscal policy when productivity is stagnant.
The BIS advocates structural reforms to boost growth potential, arguing that chronic slow growth in the western world reflects supply-side constraints that can only be addressed by removing impediments to growth and deregulation. As symptomatic of supply constraints on growth, it cites both persistent current account trade deficits and lower unemployment rates than GDP growth normally implies in Canada, the U.S. and the U.K. This contradicts the conventional view that habitual slow growth reflects a deficiency of demand that can be addressed with yet another round of expansive (and expensive) fiscal and monetary policies. The key is how to interpret historically low interest rates: Are they the welcome result of disinflationary pressures from weak growth, or are they unsustainable because they fuel “financial imbalances that, at some point, will cause serious economic damage,” as the BIS report speculates?
The BIS recommends the reorientation of both monetary and fiscal policies away from a fixation on short-term stimulus to a focus on stability in asset markets and the balance sheets of the public and private sectors. It acknowledges this might not lift growth in the short term. But the relentless focus on short-run changes in aggregate demand since 2008 failed to improve long-term growth, while creating imbalances that risk precipitating another financial crisis even while impairing governments’ capacity to respond.
Philip Cross is the former Chief Economic Analyst at Statistics Canada.