CPP expansion will shrink available investment capital

Business investment in Canada is second last among the 17 OECD countries.
Image: Fotolia

Canada has a growing investment problem. Business investment (excluding residential structures like houses and condos) has dropped nearly 20% since 2014. The level of business investment (as a share of the economy) in Canada is now second lowest among 17 advanced countries.

Meanwhile, foreign direct investment into Canada has plummeted, and the ongoing saga of the Trans Mountain pipeline raises serious questions about Canada’s ability to attract capital for major resource projects.

Unfortunately, expansion of the Canada Pension Plan (CPP), which begins next year, will make the investment problem even worse by reducing the money available for domestic investment. This matters because it could leave less money available in Canada to finance innovative startup businesses, the maintenance and expansion of existing operations, and investments in new machines and technology – all of which are critical for improving the economy and living standards of Canadians.

Starting in 2019, Ottawa and the provinces will force Canadian workers to increase their CPP contributions, with increases phased in over seven years. However, between 1996 and 2004 when Canadian households were forced to increase their CPP contributions, they reduced the amount they saved in private vehicles such as registered retirement savings plans (RRSPs), mutual funds and tax-free savings accounts (TFSAs). Research found that for every $1 increase in CPP contributions, the average Canadian household reduced its private savings by approximately 90 cents.

As CPP expands and more money shifts from private saving vehicles to CPP, there will be a decline in domestic investment. Why?

Because the private savings of Canadian households are predominantly invested in Canada. Private investors prefer investing in their home country over foreign countries. For example, in 2016-17, Canadian households kept 82.2% of their financial investments in Canada, with only 17.8% invested in other countries.

But the opposite is true for the Canada Pension Plan Investment Board, which manages the invested portion of CPP contributions. In 2016-17, 83.5% of the board’s holdings were invested outside Canada and only 16.5% in Canadian investments.

As noted in a recent Fraser Institute study, if Canadians respond to the upcoming CPP expansion like they did during the last CPP expansion, we estimate that in 2019 domestic investment would be approximately $1.1 billion lower. By 2030, five years after the CPP expansion is fully implemented, the annual reduction in financial assets invested by Canadian households in the domestic market will be $14.8 billion. Cumulatively, CPP expansion could result in a reduction in domestic investment up to $114 billion from 2019 to 2030.

The solution is not to impose foreign investment restrictions on the CPPIB. This is a bad idea – the board (and Canadians in general) should be free to invest broadly in assets that will generate the highest risk-adjusted rate of return, regardless of location.

But at a time when investment in Canada is declining, expanding the CPP will only add to the country’s investment woes.

In response, Canadian governments should pursue policies to help spur investment, and in many cases this means a complete U-turn on the policy approach taken over the past three years.

This article was co-written by Taylor Jackson. Lamman and Jackson are the co-authors of the Fraser Institute study Expansion of the Canada Pension Plan and the Unintended Effect on Domestic Investment.

© Troy Media 2018