Published On: Friday, 03 November 2017

Economic Storm Clouds on Canada’s Horizon

Economic Storm Clouds on Canada’s Horizon

- Charles Lammam is director of fiscal studies and Hugh MacIntyre is a policy analyst at the Fraser Institute.

CANADA - During the recent federal fiscal update, Finance Minister Bill Morneau said higher-than-expected economic growth for 2017 is evidence that the government’s plan is working. In reality, however, little of what’s driving growth for this year has anything to do with government policy. And economic storm clouds remain for 2018 and beyond.

Let’s start with the 3.1 per cent growth expected this year. To some extent the improvement in the economy is grounded in the rebounding of commodity prices – nearly 40 per cent of second quarter growth came directly from the energy sector.

Also unrelated to government policy, a buildup of auto inventories in the United States has helped boost exports in the first half of 2017. According to Statistics Canada’s former chief economic analyst, this is a short-term effect due to planned cuts to production and not an anticipation of higher auto demand.

And while Morneau says the Canada Child Benefit has helped stoke consumer spending, the Bank of Canada recently noted that this government transfer amounts to a one-time boost rather than a long-term driver of economic growth.

And that’s the problem. Since coming to power, the Liberal government of Prime Minister Justin Trudeau has done virtually nothing to improve Canada’s prospects for long-term economic growth. In fact, in many ways it has damaged the prospects for a sustainably stronger economy.

The Bank of Canada expects growth to moderate and drop to 2.0 per cent in 2018 and 1.6 per cent in 2019. Even Morneau’s own department expects growth to drop after 2017. The fact that the Bank of Canada, private-sector forecasters and the Department of Finance expect growth to slow in coming years to below 2.0 per cent reveals a deeper concern regarding the state of Canada’s economy.

Canada’s future growth is expected to be hampered by some critical flaws in our economic fundamentals, particularly the slowdown in business investment. When businesses invest in the latest technologies and production techniques and expand operations, it spurs economic growth and raises living standards for workers. And that happens because that investment makes workers more productive, which in turn allows them to command higher incomes.

But a recent study showed that business investment in Canada has declined a staggering 18 per cent (after accounting for inflation) since the end of the third quarter of 2014. By international standards, Canada’s rate of business investment ranks second lowest among 17 comparable industrialized countries in annual investment as a percentage of gross domestic product from 2015 to 2017. Looking further back, investment in machinery and equipment – a critical type of investment and driver of rising productivity – has fallen steadily since 1998.

Crucial to any plan to improve Canada’s long-term economic prospects is encouraging private-sector investment, innovation and entrepreneurship. But here, too, federal policy choices have been counterproductive.

For instance, the federal government has increased the top personal income tax rate, capital gains taxes, payroll taxes and mandated new carbon taxes. At the same time, it has created considerable uncertainty regarding plans for further tax hikes that will cause damage, particularly on entrepreneurs and investors.

And Morneau’s fiscal update makes clear that the government will continue to run persistent deficits and rack up more debt. That signals potentially higher taxes in the future (debt is simply deferred taxation), creating yet more uncertainty today among investors and entrepreneurs.

It’s no wonder that Canada’s investment climate has deteriorated in recent years.

Canada’s ranking in the World Bank’s Ease of Doing Business report has dropped to 22nd this year from 14th the previous year. Moreover, a recent survey found that 64 per cent of chief executive offers said Canada’s investment climate had worsened in the last five years, noting increased tax and regulatory burdens.

Meanwhile, confidence among small businesses has plummeted, according to the Canadian Federation of Independent Business.

By touting this year’s uptick in economic growth, Morneau is encouraging complacency among policy-makers (and Canadians more broadly) about the reality of our economy. And that reality is not very positive.

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