The recession drove up public deficits, but Canadians understand the need to restore fiscal balance. Meanwhile, governments are moving to reform the tax system in ways that will boost investment.
This is a big year for Canada, as we host not only the Winter Olympics, but also the G8 and G20 summits.
As we prepare for these major events, it is important to consider the current environment and some of the key challenges and opportunities facing Canada today. There are a number of factors that significantly change the context for these meetings.
The first thing is that the global economy is more volatile now than at any time since the Second World War. The financial crisis began in 2007 with the bursting of the US housing bubble, which in turn contributed to the collapse of a number of major financial institutions, sharp declines in stock market and real estate valuations, the shattering of consumer confidence around the world, rising unemployment and calls for massive infusions of public money to arrest the downturn and prime the pump of recovery.
Earlier this year it looked to some observers as if we had finally turned the corner on the so-called Great Recession, but recent events in Europe show that those hopes may have been premature. The difference now is that in addition to worrying about overextended consumers and homeowners who cannot pay their mortgages, we also have to deal with the consequences of all that stimulus spending and the resulting explosion in levels of sovereign debt.
In May, the spotlight was on Greece, where years of unrestrained government spending has saddled the country with a national debt larger than its entire economy. The big question became whether Greece was a harbinger of further debt crises elsewhere in Europe and beyond, and whether the contagion would continue to spread to other countries with high debt-to-GDP ratios. It certainly would be foolish to assume that we are out of the woods, and at the very least, the massive bailout plan for Greece arranged by the European Union in May is going to exacerbate the fiscal pressures on other European governments, exerting a drag on economic growth for years to come.
It used to be said that when the United States sneezes, Canada catches a cold. This time it was different: the impact of the recession was not as severe in Canada as it was on the other side of the border. Nor have we suffered as badly as Europe. According to Statistics Canada, our economy shrank for three consecutive quarters, from the autumn of 2008 through to the summer of 2009. Elsewhere among the nations of the G7, the recession lasted anywhere from four to six quarters.
Of course, this does not in any way lessen the pain for those Canadians whose jobs and incomes have been affected by the downturn. But the trend is moving in the right direction. In April the number of Canadians with jobs rose by 109,000 — the largest monthly gain in percentage terms since 2002. The jobless rate, which peaked at 8.7 percent in August of last year, dropped to 8.1 percent. Meanwhile, the consensus among international forecasters is that Canada will lead the G7 this year and next in economic growth.
Clearly, we have a lot going for us. Our financial system and institutions were tested during the financial crisis and have proved sound. Canada’s banking system is now widely viewed as the most stable and efficient in the world. Meanwhile, inflation and interest rates remain low, our currency is strong, our public deficits and debt remain modest relative to those of our major partners, and our tax rates are looking increasingly attractive.
It is an encouraging picture, but we cannot afford to be complacent. It was not sheer luck that enabled our economy to perform comparatively well during the downturn. Yes, we benefit from being a major supplier of energy and other raw materials in an era of rapid demand growth from emerging economies. Canada is rich in natural resources and we should never take that endowment for granted.
We need to find ways to ensure that Canadian companies invest more in research and development. Right now Canada ranks 16th out of the 30 OECD countries in business spending on R&D.
But the most important reason for our economy’s relatively good performance over the past couple of years is that we entered the downturn in a position of fiscal strength. Back in the 1990s, Canada almost hit the debt wall — the same wall that Greece has just crashed into, and that a number of other countries are getting dangerously close to. In 1995-96, the federal debt was greater than two-thirds the size of our total economy, and the Wall Street Journal proclaimed that we had attained honorary Third World status. Fortunately, we became serious about reducing our deficits, and three years later we announced the first of a string of surpluses. It was not easy. We had to cut spending, something no politician ever likes to do. We also had to raise taxes — not in terribly obvious ways, but by benefiting from less than full indexation of tax brackets (so-called “bracket creep”), running up large surpluses in the unemployment insurance account, increasing user fees, privatizing certain assets and so on. And of course we were helped enormously by the fact that during the 1990s interest rates were falling — which meant that each year it was costing us less to service the debt, while simultaneously stimulating private sector investment. When you are carrying a mortgage of close to $600 billion, lower interest rates are nothing short of a godsend.
That pattern of federal budget surpluses continued until the 2008-09 fiscal year, and in the process successive Liberal and Conservative governments drove the federal debt-to-GDP ratio down to 31 percent. As a result, when the recession struck we were in a position to ratchet up public spending without seriously straining the capacity of the federal government to pay its bills. The lesson here is obvious. Governments, like consumers, can spend money they do not have, but they cannot do it forever — and if they cannot balance the books when times are good, they are going to be in big trouble when the going gets ugly. If they did not already know this in Greece, they know it now — because the banks have just cut up their credit cards!
My point is that even though Canada is in relatively good shape, we need to get back to fiscal balance as quickly as we can. It’s not going to be easy. In some ways, it is actually going to be trickier than it was in the 1990s, because this time interest rates will be going up. To have any hope of stemming the tide of red ink, governments will have to keep a tight lid on spending. This will be an especially daunting challenge at the provincial level, where every government faces the same huge problem: a public health care system that is chewing up about half their budgets, with costs that are growing at about 6 percent a year. This simply isn’t sustainable: governments know it; the opposition parties know it; doctors, nurses and hospital administrators know it too.
One result, as in the 1990s, is that governments also will be looking for new sources of revenue. Quebec and Nova Scotia have been the first to bite the bullet and raise taxes. They almost certainly will not be the last.
How do you design a tax system that encourages investment and job creation, that improves your ability to compete with other jurisdictions, and yet allows governments to continue to provide services like health care, education, environmental protection, new roads, public transit and everything else we Canadians take for granted?
In answering that question, I start with the principle that taxation is a necessary evil, and thus tax policy should rely most heavily on the forms of tax that are least damaging to investment, job creation and competitiveness. That’s why I support the decision of the Ontario and BC governments to harmonize their retail sales taxes with the GST. The harmonized sales tax gives provinces necessary revenue while at the same time slashing the effective marginal tax rate on new business investment — which is what will drive more and better jobs in the years ahead.
That same concern for competitiveness is why I support the federal plan to lower the statutory corporate tax rate to 15 percent by 2012. Corporate tax rates, both federal and provincial, have come down a lot over the past decade, and those reductions have been supported by governments from the left, the right and the centre of the political spectrum. Behind this strategy is a recognition that few things matter more to Canada’s economic health and future prosperity than its ability to attract and retain investment. For a number of years Canadians relied on a cheap dollar to make their goods more competitive in foreign markets, but those days are gone. To compete for investment today, with our dollar strong and growth in many of our export markets still weak, Canada needs a significant tax advantage.
The good news is that we have already made a lot of progress. By 2012 — with the cooperation of most of the provinces, and assuming the planned federal cuts go ahead — Canada should have the lowest statutory corporate income tax rate in the G7. As well, our overall tax rate on new business investment will be below the OECD average.
So reforming the tax system in a way that promotes business investment and growth is a hugely positive move. Another important step is to build on Canada’s record as an exporting nation by enhancing our ability to trade and do business around the world. The Canadian Council of Chief Executives has taken the lead within the private sector by strongly supporting the current negotiations toward a new economic partnership with the European Union. This is, without a doubt, the most significant trade initiative that Canada has undertaken since the early 1990s, and it is the first time ever that the EU has negotiated such a deal with a developed country. If we succeed, Canada will enjoy the benefit of being both a member of NAFTA and a privileged partner of the EU, the world’s largest single market and biggest investor.
As our country emerges from the downturn, we have a lot of things going for us. The recession forced our governments to run big deficits, but I believe Canadians understand why it is now vital to restore fiscal balance. And at a time when some other countries are resorting to beggar-thy-neighbour protectionism, Canada is pursuing a course of greater openness. These are all key ingredients of a winning economic strategy.
But there are other areas where there is still a lot of work to do, and one of the most glaring is in the area of productivity. This is not a new issue, of course. As federal industry minister in the 1990s, I often expressed concern about Canada’s lagging competitiveness and tendency to hide behind a low dollar rather than investing in innovation.
Unfortunately, the problem is not going away. During the past 10 years Canada’s annual labour productivity growth has averaged a pitiful 0.7 percent. That is well below the US pace and half the rate recorded in Canada during the 1980s and 1990s. The Bank of Canada says that if the current trend continues, our future economic growth will be cut by a third. Over the next decade, that would mean a loss of income of $30,000 for every Canadian.
There is no simple solution to this problem. But there are three specific areas where Canadians, and Canadian companies, clearly need to pick up their game.
First, they need to increase their investment in the fundamental drivers of productivity: machinery and equipment, training and innovation. Second, Canadian workers need greater access to the latest information and communications technology — the tools that let us do more, faster. And third, we need to find ways to ensure that Canadian companies invest more in research and development. Right now Canada ranks 16th out of the 30 OECD countries in business spending on R&D.
Unless we fix this problem, our children and grandchildren are going to pay the price in terms of a lower standard of living. That is why I and a number of other leaders from the business and academic communities have agreed to form a Coalition for Action on Innovation. We are going to focus particular attention on what needs to change in the private sector, and on how Canada can maximize the contributions of its academic institutions to our national economic success. For Canada’s business community, this has to be a priority, which is why my organization intends to make the innovation agenda a central focus of its work going forward.
Another opportunity is the first-ever G20 Business Summit, or B20. The Canadian Council of Chief Executives will coordinate and host this meeting, which will occur just before the G20 leaders meet in Toronto in June. Prime Minister Stephen Harper has written to each of the other G20 leaders to advise them of B20, and Finance Minister Jim Flaherty has asked each of his counterparts to include two top business leaders in their summit delegations.
During this critical period, it is vital that governments and the private sector work closely together. Since the recession began, governments around the world have spent heavily in a bid to arrest the slide and nurture a return to growth. But the spending binge is now winding down. Greece, Portugal and Spain have announced tough new austerity measures. Britain’s new governing coalition is vowing to do the same. Most other G20 countries also face years of spending restraint.
With governments stretched to the limit, the responsibility for investment, growth and job creation now falls more heavily on the private sector. We need to ensure that public policy enables that growth. We need to oppose protectionism whenever and wherever it arises, and renew the push for multilateral and regional trade liberalization. We need to reform the international financial regulatory framework in ways that encourage the prudent management of risk, instead of imposing new rules that fail to address the causes of the global credit crisis. In particular, we should be ensuring that financial institutions maintain levels of capital sufficient to prevent future failures rather than levying a new global tax to pay for the bailouts of institutions that take excessive risk. All these issues will be on the agenda of this summer’s G20 Business Summit. The summit will succeed if it offers practical, constructive advice to the leaders of the G20 nations.