How do we increase economic growth and create more and better jobs?
This, says Stanley Fischer, vice-chairman of the U.S. Federal Reserve, is the biggest challenge facing economic policymakers. In fact, he asks, is this is possible or is slow growth the new normal?
Growth prospects are typically framed as the economy’s potential growth rate. And Canada’s potential growth rate has been declining for some time, with big implications including a slower improvement in living standards, more unemployment and weaker growth in tax revenues and hence the ability of government to deal with big challenges such as an aging society.
Instead of Freedom 55, we now talk of Freedom 75.
An economy’s potential growth rate is typically determined by the rate of growth in the labour force and the rate of growth in productivity. It is often defined as the speed limit of the economy, since it is the rate of growth possible without igniting a high rate of inflation. With the rate of growth in the labour force declining, productivity gains have become much more important in shaping our future. As it is, per capita GDP, adjusted for inflation, was only 2.2 per cent higher in 2013 than in 2006, when Stephen Harper became prime minister. That’s not much of a gain over eight years.
TD Economics recently published a report on Canada’s long-term growth potential. As it points out, while Canada has fared better than the U.S. since the Great Recession, over the past 50 years the U.S. has enjoyed faster trend economic growth than Canada, with stronger productivity growth outweighing Canada’s faster labour force growth.
But its sobering message is that “economic growth will not be what it used to be in either the U.S. or Canada over the next decade. By 2018, we expect the U.S. to grow at a trend rate of around two per cent and Canada slightly lower at 1.8 per cent.” With a potential growth rate of 1.8 per cent, it would take 38.3 years to double living standards, compared to 27.6 years with the 2.5 per cent potential growth rate in the early part of this decade.
The fiscal strategy of the Harper government has meant slower growth in Canada over the past couple of years. That’s because it cut back on discretionary spending, with large-scale government layoffs and elimination or reduction in programs, including infrastructure investments, making a balanced budget its priority instead. This meant fiscal stimulus was withdrawn too soon. A few more years of deficits would not have mattered.
More federal spending — for example to support future growth by measures to improve productivity through research and development and other drivers of innovation, renewal of public infrastructure and improved skills training — would all have helped boost productivity. Moreover, despite cuts in corporate tax rates and the low interest rate policy of the Bank of Canada, business has not been investing for the future. Instead, it is sitting on record levels of cash, what former Bank of Canada governor Mark Carney called “dead money.”
Business in Canada, unlike the U.S., is holding back even on research and development spending for new products and processes meaning it will be less prepared for future innovation and competitiveness.
A new report from Statistics Canada shows that projected business spending of $15.4 billion on R&D this year will, after adjusting for inflation, be just 84 per cent of what it was in 2007, the year before the Great Recession, and lower even than what it was in 2000. Business is simply not contributing to the productivity gains we need to improve our potential growth rate.
The encouraging opportunity, as the Fed’s Fischer has pointed out, is that there is great potential for productivity growth in the emerging market economies, such as China, India, Brazil and Indonesia.
Their gains also can benefit us, but only if we improve our capacity to export to those markets. And we are not doing that well today. There is much untapped opportunity for public and private investment within Canada as well. But to trigger this we need national strategies and incentives — for example in making the transition to a low-carbon economy or for modernizing infrastructure.
The IMF’s Fischer is right in arguing that boosting the potential growth rate is the key economic challenge. This, and helping lower income Canadians, should be the top priorities for the next federal budget.
Economist David Crane is a syndicated Toronto Star columnist. He can be reached at email@example.com.