The reasons for the failure of stimulus should be a lesson to policy-makers that simply administering more of the same ineffective medicine isn’t what will get us to better economic health, writes Philip Cross.
By Philip Cross, Dec. 16, 2016
A number of trends in the Canadian economy continued in the third quarter that continue to frustrate the stimulus that governments keep saying will come any day now from their fiscal and monetary policies. The most striking sign of trouble in the recently released third-quarter National Accounts report was in the pattern of borrowing and saving. All sectors of the Canadian economy are now net borrowers, with governments and corporations this year joining households in spending more than they take in.
Net borrowing by corporations reached an annual rate of $19.7 billion, their second consecutive deficit. The notion of firms sitting on piles of what former Bank of Canada governor Mark Carney called “dead money,” if it was ever true, was quickly made obsolete by the collapse of oil profits. Net borrowing by households, meanwhile, totalled $30.5 billion in the third quarter, less than their borrowing in last year’s third quarter. But governments ran a total deficit of $37.6 billion; in the summer of 2015 it was less than $15 billion. Most of this increased borrowing reflects federal finances, which flipped from small surpluses to deficit. It’s worth noting that none of this increase reflects higher spending on infrastructure, which rose by only 0.8 per cent in the past year, a marked slowdown from nearly five per cent in 2015.
Households and provinces are using federal stimulus to bail themselves out of the debt they gorged on for years, not to stimulate.
The third-quarter federal deficit was swollen by transfers to households, mostly for the Canada Child Benefit. What families had left from that handout, after rising consumer prices took their bite, they saved. Provinces did something similar, using bigger transfers from Ottawa to reduce their net borrowing, which is partly the reason that more federal transfers didn’t lead to more infrastructure investment but, rather, less of it. Households and provinces are using federal stimulus to bail themselves out of the debt they gorged on for years, not to stimulate.
Worrying, too, is that exports of manufactured goods have failed to respond to a lower exchange rate. The hoped-for rotation of growth from household spending to business investment and exports remains on hold. Business investment fell for an eighth straight quarter. Exports are slightly below their level of a year earlier.
The Bank of Canada had expected a quick transition from energy to non-energy export growth. Instead, exports of all manufacturing goods have essentially stagnated over the past year.
The puzzling weakness of manufacturing exports has forced the Bank of Canada to repeatedly change its narrative. Initially it attributed the weakness to a loss of capacity, theorizing that Canadian factories were closing due to a loss of competitiveness, then it pulled the recession in for blame. None of its past statements blamed factors such as sharply rising electricity rates and proliferating regulations in Ontario, but they didn’t explicitly rule them out. Still, this past January, the bank was pointing the finger at currency markets, noting that while the Canadian dollar had fallen, other currencies had too, negating the competitive advantage of a lower loonie. Come October, it said this factor “appears to be more important than previously assessed.”
The longer the manufacturing recovery takes to arrive, the harder the bank must look for reasons to explain its delay. It now cites a wide range of policies that affect the attractiveness of investing and producing in Canada, some specific to Ontario. These include “energy cost differentials, rising non-tariff barriers, uncertainty about the status of current and future trade agreements, and slow and complex project approval processes.” The bank noted that firms have been meeting increases in export demand through their foreign facilities rather than exporting from Canadian factories and that, “In this context, persistent productivity underperformance and stronger relative wage gains in Canada have been working to gradually erode the competitiveness of Canadian exports, despite the depreciation of the Canadian dollar in recent years.”
If policy-makers don’t switch from failed stimulus to fixing structural problems soon, it won’t be long before Canada’s no longer merely facing economic malaise, but a far more serious crisis.
After years upon years of failing to reignite faster growth, the frustration of policy-makers has grown palpable. It was behind Mark Carney’s mistaken and futile appeal for firms to spend alleged hoards of “dead money” (in retrospect, the wiser move would prove to be banking extra cash for the cyclical slump in earnings that soon followed). Government transfers aren’t being spent; supposed government investment has not materialized. Economic growth remains sluggish, job growth anaemic.
The stimulus is not working as expected, and the reasons for that, now clearer, should be a lesson to policy-makers that simply administering more of the same ineffective medicine isn’t what will get us to better economic health. Beware of more debt in the name of transferring income to households and provincial governments for spending, since they’ll only be keen to use it to deleverage their own balance sheets instead. Meanwhile, conducting monetary policy stimulus through a devalued exchange rate ignore the structural impediments to manufacturing growth, including high electricity and unit labour costs in Ontario, that are encouraging firms to transfer production to the U.S. Now, with a Trump presidency promising a more attractive tax and regulatory regime, the incentive for producers to shift factory output south will only grow that much bigger. If policy-makers don’t switch from failed stimulus to fixing structural problems soon, it won’t be long before Canada’s no longer merely facing economic malaise, but a far more serious crisis.