Trade, deficit reduction and tax reform critical as recession looms

The federal government must act quickly on three fronts if it is to head off economic disaster.

September 26, 2018   Livio Di Matteo

North American Free Trade still in limbo.

With the resumption of Parliament, Canada’s policy-makers face a turbulence. The US and China are waging an economic Cold War armed with tariffs.

And Ottawa continues negotiating with the administration of US President Donald Trump over the North American Free Trade Agreement (NAFTA), with an American deadline looming on Sept. 30.

Alongside all this, there’s mounting evidence that Canada’s economy and federal fiscal situation are declining and that we may be on the verge of a recession. Indeed, the economic challenges facing the Trudeau government are intensifying.

For example, the unemployment rate in August rose to 6% with Ontario leading the way, losing about 80,000 jobs. Rising interest rates, combined with economic uncertainty on the trade front, have eliminated the economic momentum that helped create a stronger employment situation. In 2017, employment grew by nearly 2%. Based on results to date, in 2018 growth fell below 1%, with July and August showing employment declines.


And slowing employment growth is accompanied by Canada’s perennial capital investment lag. As noted in a recent Fraser Institute study, the growth of overall capital investment in Canada slowed substantially from 2005-2017 and was lower than in virtually any period since 1970.

More ominously, it appears the shares of total investment in machinery and equipment – the core of investments needed to boost economic productivity – have been declining while the share of total investment accounted for by housing is up.

The delay of the Trans Mountain pipeline project is a serious blow to boosting productivity in our natural resource and transportation sectors, given that so much of our transportation network is geared towards the movement of natural resources including oil and gas.

In fact, Canada’s capital investment performance has looked better than it actually is because of the hot housing sector. Given that so much of Canada’s recent economic growth has been tied to housing wealth, indebted consumers will be stressed if employment losses mount and interest rates continue to rise.

The slowdown in the housing market in response to government policy initiatives and the gradual rise in interest rates makes the deterioration in the business investment climate even more serious.

Uncertainty over NAFTA, and a more tax competitive US business sector, don’t bode well for a pickup in Canadian business investment, especially in the absence of any aggressive measures on the corporate tax front.

And if all this is not enough to keep Finance Minister Bill Morneau up at night, a slowing economy means that the federal deficit projections in the 2018 budget may be underestimated if government revenues weaken. The 2018 budget forecasts continuous deficits that would see net federal government debt rise from $757.8 billion in 2018-19 to $831.5 billion by 2022-23 – an increase of nearly 10%.

Moreover, the optimistic forecasts of gross domestic product growth in the budget made for a declining federal debt-to-GDP ratio – but that’s certainly not in the cards if the economy slides into recession. If debts and deficits are higher than projected, it will be yet another blow to business investment confidence in Canada.

The Canadian economic train may be close to going off the rails.

To improve the country’s business investment climate, the government should have three main priorities:

• resolve the trade situation with the U.S. via a new agreement or other significant initiatives designed to boost and diversify our trade;

• rein in the federal deficit now, in advance of any further economic slowdown, which would increase our already large federal deficits and debt;

• reform corporate taxes to make our business sector more competitive.

The time to act is now.

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