Freeland’s economic update needs to be realistic and honest

TORONTO—Sometime soon, Finance Minister Chrystia Freeland will have to present the government’s economic and fiscal outlook. This is a critical part of the budget process because, if done properly, it sets out the framework for policy choices in next year’s budget. Given the precariousness of both the Canadian economy and the global economy, it’s more important than ever that the update be a frank and honest accounting of where we stand, and not another exercise in unwarranted boastfulness about doing great things together. In its own understated way, the Bank of Canada’s latest Monetary Policy Report points to difficult and challenging times. It reports that “there is more evidence the economy is slowing” though the R-word (recession) is avoided. But the report acknowledges that, despite the economic tightening currently underway, “the pace of future declines in inflation remains uncertain. Core inflation has been more persistent than expected.” Indeed, recent increase in the interest rate of Government of Canada 10-year bonds shows that financial markets expect higher interest rates to be with us for some time. And high interest rates affect both business investment and household spending. Economic growth in the second quarter of this year was “well below expectations.” Not surprisingly, the Bank of Canda has lowered its economic forecast for the next several years, compared to its July projections. Layoffs by several of Canada’s major banks and other inimical institutions is just one sign of troubling times. The Bank of Nova Scotia recently announced laid off roughly 3,000 employees, and Desjardins another 400. Earlier, RBC had announced layoffs, as had BMO, while CIBC has indicated similar steps. One of the most worrisome warnings in the Bank of Canada's report is the slowdown in business investment: “Since mid-2022, growth in business investment has been modest.” In particular, investment in machinery and equipment has fallen about 10 per cent. Yet this particular investment is an important element in improving Canada’s lacklustre productivity performance. Looking ahead, the main driver of potential output in the economy will be strong population growth from immigration, and an upsurge in temporary workers. But this does not translate into per capita economic gains. It is through productivity that the real gains will be achieved. External forces will also have an impact. Our interest rates will be determined not just by our success in lowering inflation in Canada, but also by what happens south of the border, where the U.S. Treasury's unprecedented need to borrow may be more than Wall Street can handle without further interest rate increases, The Wall Street Journal reports. For fiscal 2023, the U.S. federal deficit was US$1.7-trillion or about 6.3 per cent of GDP, with U.S. federal debt now at 98 per cent of GDP, or almost the same level as coming out of the Second World War. The American government owes about US$25-trillion to the rest of the world. But there is a risk that the foreign buyers of U.S. federal debt may feel they hold enough. Japan—the largest foreign lender to the U.S.—has already cut back its holdings. The government bond rate matters in three ways: first, interest costs for businesses and households are closely linked to the rates needed to sell U.S. government bonds; second, any upward pressure on U.S. bond rates will inevitably spill over into Canada even if, on a relative basis, our situation is better; and third, the valuation of stock market shares are linked to bond rates—if bonds are paying higher rates then share prices are likely to be lower, affecting pension savings. So in this year’s economic and fiscal projections, Freeland has a particular obligation to be up front with Canadians on the challenges we face not just the short-term challenges of getting us back to a stable and lower rate of inflation, but also in providing the government’s best thinking on how we move forward for a more productive economy. This economy should be on a path to net-zero emissions, much less dependent on oil and gas for export revenues, and much more competitive in the industries and jobs of the future. For too long, the government has been glossing over the challenges we face. For example, if we are transitioning to an electric-energy economy, how is the massive new electricity generation to be built and paid for, and by whom? The cost will be huge, but so will actual implementation: technology choices are limited largely to nuclear and wind. But will the regulatory approval process allow projects to go ahead on a timely basis, will the skilled workers be there to build these systems, and will the technologies by sufficiently advanced and economic? And how much Canadian technology will there be? Likewise, how do we improve our productivity through innovation, so as to raise the economy's potential growth rate. That’s critical for the diversified growth and wealth creation we will need to sustain and improve our way of life as our society ages, and global insecurity increases. The Bank of Canada’s latest report glosses over the productivity issue while, despite some eight budgets, the government has never given a satisfactory analysis of why our productivity is so poor, and what would it take to improve performance. Instead, we get aspiration, boasts and wishful thinking. As a country, we cannot afford that going forward. For example, we have relied too much on oil and gas to carry the day, but as the International Energy Agency recently warned, world demand for oil could be cut in half by 2050. What will replace the fossil fuels industry, which accounts for about 26 per cent of merchandise exports? We have been putting off facing reality for too long. But Canada cannot take its future for granted any longer. We need a government—and country—that recognizes that and is prepared for hard choices. Freeland needs to be realistic and honest about what those should be. David Crane can be reached at crane@interlog.com. The Hill Times