How to Foster Enterprise and Innovation
INTRODUCTION
Three years ago I said that Justin Trudeau’s government could not afford to ignore Canada’s two major economic challenges – living beyond its means as a country and doing something to strengthen its private-sector goods and services competitive supply capacity. Unfortunately, my advice has been ignored. Consumer spending and foreign borrowing were the major culprits then – and this situation has not changed. Canada’s fiscal and monetary disciplines are still too weak. Trudeau is making the same mistake his father, Pierre Trudeau, made in largely ignoring the private-sector economy. His early “sunny ways” were not followed by the foresight to see that the Canadian economy would be heading toward the rocks – despite an increasingly strong US expansion reinforced by a synchronized global expansion. Fortunately for Justin Trudeau, the crisis will not take place until after the fall 2019 election, and the next government will still have time to get onto a better economic growth path – no/low carbon oil sands, a Quebec Hydro Energy corridor, and a capital pool approach to taxing entrepreneurs to support investing in Canadian hi-tech global competitiveness advantages.
The bottom line is simple. The Harper government mismanaged the strong position Canada emerged with after the post–Lehman collapse crises. Justin Trudeau’s government has failed to take advantage of Canada’s post–Lehman strengths and the subsequent emergence of a broad, synchronized, global expansion now ending. Its problem is not primarily its government’s deficits. Rather, it is what the deficits are being spent on – consumption. The government deficits are proportionately much smaller in Canada than in the United States, but the household-sector debt has become so high that Canada’s strong private-sector consumption is bound to weaken. Finance Minister Bill Morneau’s first budget failed to get Canada started on the right path. His next two budgets also failed. An election year budget early in 2019 had no chance of making a stand on getting the needed strengthened economic and financial disciplines. That discipline will be the hard challenge for whoever forms the government after the October 2019 federal election.
The Bank of Canada under Governor Stephen Poloz remains confused, with no effective policy for a country living beyond its means at a time when it should have been moving strongly toward living within its means. The Conservatives and the media focus today on federal government deficits. Their real focus should be on Canada’s high current account deficits and rising household-sector debt. Understandably, the Conservatives avoid both issues because real economic adjustments and the inevitable political pain would be involved.
Three years ago, Canada needed more balance between natural and human resources (that is partly happening now, but mostly not thanks to federal economic policy) and between indebted sectors (three of Canada’s four biggest provinces, the exception being Quebec, are getting more indebted, alongside households and the country as a whole). Only Quebec, in 2019, has retained Canada’s good post-war balance between social and economic advance. To make it in the big leagues, even a politician needs more than one pitch. Justin Trudeau has not yet shown he has that ability, nor have the federal Conservatives.
The Trudeau government got an economic wake-up call three years ago. It may now be too late to show it has heard it. Both the federal government and the Bank of Canada have provided too much stimulus for too long for the wrong purpose – consumption. Instead of spending to help build a stronger and more competitive private sector, they have been spending on consumption. That is unsustainable. A recession is likely (but not certain – we are in a different world from that in 1945) within eighteen to thirty-six months. The Bank of Canada will be of little help this time round, and public spending cutbacks will be unavoidable. This dire forecast did not have to be.
Canada would benefit from a new hard look at its economic future:
• The premiers of the four largest provinces (Ontario, Quebec, Alberta, and British Columbia) should already have called for a Canadian Economy of Tomorrow Conference in the way Ontario premier John Robarts and Quebec premier Daniel Johnson did in 1967 when they invited other premiers to Canada’s Confederation of Tomorrow Conference.
• Ottawa should propose a lifetime capital pool approach to capital gains taxation – an incentive to make, save, and reinvest capital gains (a reward for those who pitch in).
• We should have a federal public review of the tax system, with a strong emphasis on competitive private-sector growth. It should be a much narrower review than the Royal Commission on Taxation (Carter Commission) launched by the Diefenbaker government in 1962, one more focused on economic growth and less on abstract “tax purity” concepts (the basis of the Carter report).
• Top Ottawa policy makers should take a hard look at (and do some serious fresh thinking about) how best to address the structural imbalances at the heart of today’s economic policy management challenges (see Chapter 22).
None of this kind of adult and professional discussion is taking place anywhere in Canada. It is now overdue. It will be required for the kind of new visions, new ideas, and new projects that Canada needs for the new world. Lester Pearson launched a Royal Commission on Bilingualism and Biculturalism; Pierre Trudeau launched a Royal Commission on the Economic Union and Development Prospects for Canada. The results of both inquiries helped to shape Canada in positive ways for challenging times.
Canada should have moved overall on all these fronts after it and the global economy started to recover from the post-2008 crises. Instead, it moved in the opposite direction under both Harper and Justin Trudeau. Trudeau should have seized the strengthening US and global economies to meet some unavoidable and difficult challenges. Now the global economic expansion is coming to an end and is being severely threatened by Donald Trump, Brexit, and China. Neither federal leader did what he should have done. These proposals are still the right things to do, but they will not be done until after the 2019 federal election. Whoever forms that government will then have to play painful catch-up.
As I pointed out three years ago, it is possible for leaders to have foresight. Neither Harper nor Justin Trudeau so far has shown the kind of foresight that Franklin Delano Roosevelt did, for example, two years before Pearl Harbor. Harper had the advantage of Canada coming out of 2008–09 stronger than any other country, but he did not use it to strengthen Canada’s economic and financial disciplines – just the opposite. The country got a second chance under Justin Trudeau, with growing US and global expansion strength, but he chose to spend, not to build. The country will now face a hard number of catch-ups when a recession likely hits in 2020–22.
Three years ago, I reported that Prime Minister Trudeau said at Davos that Canada would not just manage change but take advantage of it. It has since been an increasingly hard three years for Canada. We have to conclude that, so far, Canada has neither managed the big changes well nor taken advantage of them. Canada is not helpless, but right now it continues on its path of weakening economic and financial disciplines. It has no new approach for the worlds of Brexit, President Trump, and President Xi Jinping. Nor does any other country. Whoever forms the federal government after October 2019 will have no choice but to find and implement a new approach to the new world we are all living in.
1. JUSTIN TRUDEAU CAN’T AFFORD TO IGNORE CANADA’S ECONOMIC CHALLENGES*
Late in 1939, Franklin Delano Roosevelt called Harry Hopkins, his closest aide, into his office. “Harry, up until now, I have been the New Deal president,” he announced. “From now on, I will be the ‘war president.’” Pearl Harbor was still two years away, but FDR could see what was coming.
Now that a new year is dawning, Justin Trudeau is in need of similar foresight. He should have the wisdom to call Gerald Butts, his closest political partner, into his office and say that, so far, he has been all about who we are and “sunny ways.” From now on, however, he will also be paying close attention to something far less esoteric: the economy.
Trudeau can still be the prime minister he campaigned to be – the champion of mutual accommodation and the notion that “better is always possible” – but only if he also goes in the right fiscal direction.
Canada’s economy is heading toward the rocks. Consumer spending and foreign borrowing to cover it are the major culprits. Trudeau must convince the country to accept a fair balance between what we want and what we can afford – between an activist government and one that rebuilds the economy. He will not want to make the same mistake his father made. Asked, after leaving office, if he had any regrets, Pierre Trudeau said yes – he wished he had paid more attention to the economy.
If his son doesn’t learn from that, we will all pay a higher price. Not only are the Canadian and global economic fundamentals weaker now than they were then but the economic legacy left by Stephen Harper is challenging.
Doing the Math
The challenge is not the deficit: Canada has the best ratio of government debt to gross domestic product in the G7. But one good number is not enough when two other key indicators are so bad that they have the economy well off course.
The first tough number is the current account deficit – that is, the gap between the value of the goods and services we import and those we export. That deficit will likely hit $67 billion this year, the result of consumer spending, not productive investment.
Another pair of dangerous numbers involves the level of household-sector debt (higher than both the comparable US figures during the 2008 crisis and that of any other G7 country today) and high prices for houses, particularly in Vancouver and Toronto.
Private-sector debt on this scale can cause people (and companies) to suddenly stop spending (and investing) so that, instead, they can pay off what they owe, which can in turn spark what’s called a balance-sheet recession. Richard Koo, chief economist of Japan’s Nomura Research Institute and a global guru on such recessions, recently said that Canada is risking one.
If it happens, the Bank of Canada will be powerless to use monetary policy to offset economic weakness, as it did in 2008–09, by lowering the interest rate. Those already focused on reducing their debt won’t go out and add to it just because the carrying cost is down a bit.
The political news is perhaps as good as it could have been. The new federal government has a majority and is broadly in tune with large numbers of Canadians. And the economic news is not in panic mode – the federal deficit forecast in the latest fiscal update from Finance Minister Bill Morneau, although higher, is not significant yet.
But it is likely to get larger because the economy, already weak, keeps declining as the price of oil drops, alongside accumulating debt challenges and not enough internationally competitive supply capacity.
Spend Only Where It Counts
This government has big plans that involve spending, but that spending must be limited to top priorities. Deficits are not Canada’s primary challenge, but if the economy is not earning its way, government spending that fails to restore its ability to do so could pose a problem.
Harper’s priorities were smaller government and reduced personal taxation – valid goals if based on living within one’s means. Instead, taxes were cut and the budget balanced even as Canadians were living beyond their means on a scale never seen before.
The new government’s spending promises and growth aspirations will make its deficit goal (a surplus by the last year of its mandate) harder to achieve. Paul Martin’s first budget as Jean Chrétien’s finance minister failed to get the country back on track – he needed a second one. Morneau’s first budget may meet the same fate.
Moreover, by Canada’s next federal election, the current US economic strength will be fading and oil prices could well be worse than expected, meaning slow growth, if not a recession, and reduced revenues in Canada. The huge household-sector debt needs to be carefully displaced by federal deficits that support investment to build the economy. There is no need for Keynesian consumer-demand stimulus – $60 billion a year in foreign borrowing is already too much.
What is needed is investment in public infrastructure and private-sector job creation to broaden the competitive supply capacity of the economy. Growth fuelled by the private sector is the only practical way forward on jobs, rising middle-class incomes, and reduced deficits.
The federal policy inherited from the Harper government, which combines rising foreign and household-sector debt used for consumption, is not sustainable.
Something Is Wrong
The Bank of Canada, among others, expected that consumer spending would be followed by investment and exports. Neither has happened or seems likely. Why has the United States experienced this rotation but not Canada? Why is US consumer strength greater than that of Canada?
The fundamental answer is that US competitive-supply capacity has been broadening, while the Canadian capacity has been narrowing. This difference calls for new creative thinking. To do well, a country needs at least one of three basic economic strengths:
• A big domestic market. Canada can never have a huge population, given its geography and climate. Trade agreements to expand markets are not the same.
• Space, food, water, minerals, and energy. Canada has them all in abundance. When it comes to natural resources, only Brazil and Russia are in the same league as Canada.
• Competitive rewards and opportunities for the best people – entrepreneurs, professionals, managers, creators, and innovators. In this vital area, Canada desperately needs new creative policies and initiatives.
Canada’s natural resources are certainly a great long-term strength, even if resource markets are cyclical. Canada’s only choice is to match strength in natural resources with strength in human resources – and we already excel in such fields as financial services, medicine, hi-tech innovation, and architecture.
Our two current economic challenges are, first, to reduce overall debt and rebalance it away from households toward the federal government; and, second, to strengthen the role of human resources in the economy. Canadians’ standard of living is declining because of its negative terms of trade (the oil-price collapse and low commodity prices), the lower dollar (which makes imports more expensive), less income growth (the weakening economy), and less consumer room to borrow. A successful new policy is essential.
The Debt Anesthetic
Canada had a huge advantage over other countries at the end of the Brian Mulroney–Jean Chrétien era, as the world fell into the post–Lehman abyss in 2008. This advantage should have been used to build our means – instead, it was used to live beyond them. Understandably, no political party has wanted to talk about it.
The problem is hardly a new one. I recall, twenty-six years before the Lehman Brothers collapse, speaking to a senior Canadian businessman who wanted me to agree that Ronald Reagan, although he had been president for just a year at that point, was a great man. I argued that Reagan was getting into too much debt, but the businessman wanted something positive out of me, so he said: “You have to admit Reagan has made Americans feel good about themselves.” I agreed, but I pointed out that if I spent more than I earned on my wife, as the president was spending on the American people, she would feel good about herself, too.
In recent years, that is exactly what Canada has done. The challenge is to take away the debt anesthetic and help people feel better about themselves by doing real things that build a more productive Canada for the future. It is what the greatest leaders are for.
Building for a better future always requires deferring consumption. That is the biggest political persuasion and policy task the new Liberal government faces. It requires a balance between personal reward and societal reward – a balance that recognizes society’s role in private opportunity and the role of privately driven economic achievements in societal opportunity. To have success that truly lasts, each side must accommodate the role played by the other.
How might these challenges best be addressed?
• High house prices–household-sector debt. The Bank of Canada must follow the lead of the US Federal Reserve and raise interest rates as federal fiscal deficits grow. We must get on the long, slow path to less household-sector debt and less foreign borrowing for the sake of consumers. We must use prospective larger federal deficits for the kind of growth that brings lasting job creation, rising incomes, and better-balanced sectors.
• Transit infrastructure. We need a much bigger program than the one currently planned.
• Wealth and job creation. We need the social licence to offer incentives that reward successes that are reinvested in the economy. This approach worked for Canada in the twenty-five years after the Second World War, when the opportunities were in natural resources. A comparable approach is needed for the first half of the twenty-first century, when opportunities lie in human resources.
In the past decade, Canada’s economic policy environment became too narrowly political. It lacked a longer-term strategy and discernible national vision for a constantly changing world. That must stop. A policy of tax cuts and no deficits is too limited. Policy and politics must return to the full playing field.
Policy Confusion
The Bank of Canada under Governor Stephen Poloz does not seem to have an effective strategy for the current Canadian economy and debt challenge. Not only do the bank’s two rate cuts this year go in the wrong direction, but Mr Poloz has added to the confusion by suggesting a policy of negative interest rates in the event of a crisis, even though he says there is no reason to expect one will happen.
In that case, two questions:
• Why talk now about something that is not needed? Is he trying to say the bank could do a lot about where we might find ourselves?
• How would negative real interest rates help us live within our means and broaden our competitive supply capacity?
Either way, the finance minister must keep on top of his department and the Bank of Canada and demand clear monthly analytical updates on both house prices and household debt. Morneau needs to know:
• What can we do, and are we doing it?
• Is that likely to work in time?
• What do we do if the job is not done in time and the bad possibility becomes real?
Mutual Accommodation Can Help
From 1945 to 1993, Canadian politics was dominated by the Progressive Conservatives and the conservative Liberals (the latter went off economic and fiscal balance under Pierre Trudeau). There were two great postwar dynasties – one federal (rooted in the conservative Liberals under Sir Wilfrid Laurier and William Lyon Mackenzie King); the other provincial (the Progressive Conservatives in Ontario under Leslie Frost, John Robarts, and William Davis).
Each shared the idea that social and economic progress go together. This policy resulted in a sixty-year mutual accommodation of these two powerful sets of aspirations. They came to be seen as mutually strengthening, not adversarial. They made today’s Canada.
Canada now needs more balance: between natural and human resources, between indebted sectors, and between social and economic advance. Those who want a strong economy must understand the need for societal strength – and vice versa. Pierre Trudeau overreached on the economy; Stephen Harper underreached. Justin Trudeau cannot get it right if he is governed by a fiscal straitjacket. No one, including the prime minister and his economic advisers, is ready yet for what is needed. A big, bold, prudent, and patient approach is the way forward.
In a recent column, the Globe and Mail’s Jeffrey Simpson said that the Liberals don’t really have their heart in fighting the deficit. Nor should they. But if the government doesn’t meet the economic challenge it faces, the social policy that is close to its heart will be undermined.
Invoking an Icon
We must echo the boldness of John A. Macdonald in building the transcontinental railway after Confederation. It will take everything Justin Trudeau has to pull it off: a capacity for mutual accommodation, the intestinal fortitude to set the right priorities, and a penchant for what works.
Pierre Trudeau kept the country together; Justin Trudeau saved the Liberal Party. Can he now do the long, hard, and bold things needed to build the country for the twenty-first century? He has shown he can be bold by doing hard politics, such as staying positive in a negative campaign and his out-of-step campaign decision to advocate running deficits. He won big by reassuring Canadians that openness, engagement, and inclusiveness are still the best way forward. Now he must turn to the economy (as well as security, both at home and abroad). If he does not become the “economy prime minister” and get the needed reforms right, he will find it almost impossible to keep his ways – and ours – very sunny.
By knowing when to change focus, Franklin Roosevelt was able to face a conflict and prevail. A quarter-century later, however, Lyndon Johnson could not keep the Vietnam War from destroying his dream of being remembered as the “Great Society president” who eliminated poverty and racial injustice.
To make it in the big leagues, even a politician needs more than one pitch.
2. TO TRANSFORM CANADA’S ECONOMY, TRUDEAU NEEDS TO BE A “BOLD BUILDER”*
Canada’s wake-up call has arrived with all the bad economic news – the falling loonie (which raises the cost of living), collapsing oil and commodity prices, a serious bear stock market, reduced government revenues, and weakening employment performance.
But bad news can include good news – and the upside is that the new government and the watching public cannot fail but see what they face. The harsh forces now at work can no longer go unnoticed. The government, four months into its mandate, is getting a clear idea of the challenges ahead – and that will help it explain to Canadians what has to be done.
The last five years were largely lost ones for the Canadian economy, which has suffered from three major vulnerabilities:
• Our growing household-sector debt and (because we have failed to live within our means) foreign borrowing.
• China’s impact on oil and commodity prices, which stems from the fact that a once-explosive economy is growing more slowly and reducing its investment in physical capital.
• Finally, the looming – and unavoidable – end to the current US expansion.
Some of these troubles were self-inflicted; others came from outside, but were at least partly foreseeable. Either way, the end result is very, very real. What matters now is to assess where we are and find the right policy and political ways forward. Canada was unprepared to deal with the first two problems. It is urgent that we get ready for the third by using US growth while it lasts.
A Hard Global Environment
The global economy is still being held back by two huge deflationary, or recessionary, drags.
CONTINUAL AFTERSHOCKS FROM 2008
We forget that the world never really came out of the Great Depression of the 1930s – rather, the economy was revived by a global war. Nor has Japan really recovered from its twenty-five years of economic malaise. In both cases, the premature withdrawal of measures to stimulate a recovery brought recession back.
This context helps to explain why the US Federal Reserve Bank has been so cautious since the 2008 meltdown – and, now that it has begun to raise interest rates, why Financial Times columnist Martin Wolf writes that the increase perhaps was a blunder. He may be right, but for once I think not – just as I don’t feel the Fed’s action is the prime suspect in triggering the current global stock setbacks.
THE CHINA FACTOR
The overwhelming shock of China’s economic rise has now turned into the shock of its lowering growth adjustments. Wendy Dobson, a China expert at the University of Toronto’s Rotman School of Business and the author of Canada, China, and Rising Asia: A Strategic Proposal (2012), points out that, while Western economies make mistakes, they have way-forward charts. For China there are no charts for moving 1.4 billion people forward, with an authoritarian government and an economy hindered by the fact it’s partly stateowned. We don’t like today’s destabilized Middle East. A politically destabilized China could be much worse.
But Canada has to look out for itself in a world of insufficient demand. Just as it needs what Prime Minister Trudeau calls “sunny ways,” it needs to be deeply rooted in reality and what works.
The Way Forward
Right now Canada needs major initiatives in three key areas: public infrastructure, natural-resource infrastructure, and incentives designed to foster the creation of wealth.
Following the 2015 election, Canada emerged with a government that supports the first of these initiatives (developing public infrastructure) and promises a more positive approach to First Nations and climate change, which could help with the second initiative (developing natural resources). Unfortunately, none of the three main parties advocated anything to help Canadians to start living within their means.
In the immediate aftermath of the financial crisis, Canada famously did almost all the right things, using the strengths from its Brian Mulroney–Jean Chrétien heritage to overcome the worst of the fallout. The Bank of Canada under Mark Carney edged interest rates up 75 basis points – an amazing accomplishment compared with the rest of the G7 developed nations. The bank no doubt wanted to do more but was held back by elections and volatile external challenges.
After the return of majority government in 2011, there was a shift, but for political, not economic, purposes. And those changes rested on an unsustainable foundation: too much foreign borrowing and too much household-sector debt.
Now, the rough new economic world Canada faces will be much more powerful in shaping future policy. No matter what the Liberal government does, any tendency to live beyond its means will be shaped more by market forces than by policies.
The Liberals put forward two positive ideas: enhanced infrastructure financed by a larger deficit and better relations with First Nations – initiatives that, together, could help to get big pipeline and resource projects moving. However, the centrepiece of its platform – a better life for Canada’s middle class – requires some heavy lifting on the economy.
The Need for Change
Canada’s overall policy is badly unbalanced: there is too much stimulus from private credit and too little from federal deficits. Interest rates are so low, housing prices in some areas so high, and many households owe so much money that the Bank of Canada is now essentially powerless to provide relief when the next recession comes, as inevitably it will. A recent poll shows that Canadians’ prime financial goal is to cut their debt, which would help even if it slows consumer demand in the process.
Now is the time for the Bank of Canada to spur debt reduction. It could do so by matching the Federal Reserve rate increases and even by retracting the two unnecessary decreases it made last year. As for the lower dollar, by raising prices it tightens domestic spending while at the same time spurring foreign demand for Canadian goods – not that earning less for what you sell is the fast track to prosperity.
It was heartening that the Bank of Canada resisted the urge to cut interest rates yet again this month. After seeing the federal budget, which is expected to land next month, it should consider an early 25-basis-point rate rise. Such an increase would signal a better sense of policy reality than its actions and talk indicated before a speech by Governor Stephen Poloz early in the new year. In it, he essentially acknowledged for the first time that we are in a world beyond monetary-policy help, one that will require hard and painful adjustments.
Canada must use the stimulus provided by the fiscal deficit the Liberals have promised to raise interest rates slowly to help achieve four goals: a stronger dollar, less inflation, somewhat lower household-sector debt, and more moderate housing prices.
Currency-exchange and interest rates are good or bad depending on whether they reflect a sound policy framework, and Canada’s overall framework has been askew for three to four years.
Too little stimulus has been focused on the economy’s true challenge: building longer-term productivity and expanding the supply capacity. Too much has gone to creating jobs in other countries because Canada has spent billions more on imports than it earned from exports.
The possibility of more personal financial prudence is a positive sign, but right now the dollar and interest rates are both too low. The federal government and central bank need to work carefully together to achieve great balance, with less risk than we are now running and a bigger cushion for the future.
What the Policies Should Be
And how do we build that cushion? Imagine the nation’s economic policy as a stool that is supported by three legs, and the first is public infrastructure, especially transit and communications. The government is making a start, but the investment will need to be bigger than it has promised and focused almost totally on what will make the economy more competitive in the longer term.
Leg two is pipeline infrastructure. Here the Liberals can benefit from their approach to policy on Indigenous affairs and global warming – issues the previous federal and Alberta governments, along with the oil and pipeline industries, were sharply criticized over during the past decade.
The third leg should be a powerful incentive for the best people to come to live and invest in Canada and for businesses that are bold enough to expand in the face of uncertain times.
The old way to promote initiatives of this kind was through tax breaks or direct government spending – and there is still a role for both approaches. But something big and new is needed on the globally competitive goods-and-services front to match the infrastructure incentives.
We need a creative way to reward those who create wealth and jobs – and who then put their gains back into the Canadian economy.
Serious Bargaining Ahead
Canada’s economics and politics tend to be more regional than national, whereas elections that bring about change are usually national, like the one last October. The provinces and the First Nations have needs – and leverage – so overcoming their differences will require political leadership, based on mutual accommodation.
Today’s regional economic tensions are not as severe as the political tensions Pierre Trudeau faced when he was prime minister, but they are still difficult for any federal government to manage alone. The eruption of protest against the Energy East proposal for a 4,600-kilometre pipeline to carry a million barrels of oil a day from Alberta and Saskatchewan to refineries in the East illustrates what may lie ahead.
Back in 1967, there was a void in national leadership before Pierre Trudeau took office. Premiers John Robarts of Ontario and Daniel Johnson of Quebec stepped in, calling their provincial colleagues to the Confederation for Tomorrow Conference. As I’ve said before, it’s time the premiers of the four largest provinces (Ontario, Quebec, Alberta, and British Columbia) did something similar and called a Canadian Economy of Tomorrow Conference.
The Future
Every Canadian prime minister faces three primary challenges: the economy, national unity, and the United States. The wider world has now added two new challenges: security and desperate people fleeing failed states and economies and the effects of global warming.
Pierre Trudeau saved Canada from separatism. Justin Trudeau promises to preserve its identity as a nation that relies on – and thrives because of – mutual accommodation. But the second Trudeau also needs to become the second Sir John A. Macdonald – the bold builder of a stronger coast-to-coast Canadian economy that flourishes both internationally and at home. It is a huge moment both for him and for Canada. The urgent question now is whether he and we can seize it.
The scale of the oil-price and global stock market collapse must be seen as wild cards that would not normally threaten the US and global economies – but could do so. If they do, it does not mean the Federal Reserve was wrong to test the waters with a 25 basis-point rise in interest rates. What it says is how very hard it is to get past the two big global drags – the post–Lehman aftershocks and the challenge of adjusting to China’s new path.
Heavy lifting and much need for mutual accommodation lie ahead. The key is to get on the right path with a lot of honest and open discussion. In all likelihood, it will take the rest of 2016 to get started.
For the government to get all parties and provinces on side for what is needed, it needs to explain the problems and the proposed solutions well. At this critical moment, the “right” policies ideally should bring little political danger from the left, and potential support from moderate Conservatives on the right. These policies should not be based on ideology or wedge politics but simply on what works.
3. TO REVIVE CANADA’S ECONOMY, REWARD THOSE WHO PITCH IN*
Vaudeville ain’t what it used to be, nor is the Canadian economy. But the economy can bounce back, and this week Finance Minister Bill Morneau announced something to help it do just that.
Largely lost in the fallout when Morneau revealed that this year’s fiscal deficit will be much larger than expected was the creation of a special agency – the Advisory Council on Economic Growth.
After years of policies that created debt at home and employment elsewhere, this country must earn its way again. Once it has delivered its first budget on March 22, the government of Justin Trudeau plans to do something much needed: It will devote the rest of the year to looking to the future. The new advisory council is being asked to recommend ways that Canada can, as the Ministry of Finance puts it, “create the long-term conditions for economic growth.”
That is clearly a step in the right direction, as long as the government recognizes what is really needed: a broad set of discussions about how best to increase productivity – especially how to revitalize the nation’s competitive capacity to supply global goods and services.
Direct government spending to spark a sluggish economy is effective in the short term, and Morneau insists the rapidly expanding deficit makes the infusion of public money more vital than ever.
But the only lasting strategy for generating jobs that are more plentiful, more satisfying, and better paid is to enlist the private sector. And I have an idea that Ottawa’s new advisory council should consider. It is rooted both in the notion that the private sector should drive the economy and the fact that private enterprises deserve a strong foundation built on social licence. In other words, ventures that make a contribution to society should be granted special privileges.
My proposal may not be the only (or even best) way forward, but it takes a practical, “what works” approach that is easy to grasp and would enable Canada not only to live within its means but to prosper.
Invest Now, Tax Later
Building larger, more dynamic pools of capital in Canada would be enhanced if investors could treat their investment capital as a single asset for the purposes of capital-gains taxation. The way to do that is to allow capital property gains to be reinvested without immediate tax.
A simple taxpayer election, like the existing rollover (deferral) provisions for a small category of capital gains, would do it. It would be available to all Canadian resident taxpayers and involve no registration requirement, only a tax-return designation. In effect, until assets in the pool are withdrawn (or so deemed on death or residence change), they would remain at work, creating businesses, jobs, incomes, and tax revenues. There would be no change in the present capital-gains system or level; no fund, plan, or administrator; and nothing directive as to qualified reinvestment. If taxpayers wished to avoid having premature taxation reduce their capital pool, they need only elect to have the cost of the disposed security become the cost of the new security in order to defer recognition of the gain.
If a taxpayer did not reinvest, a taxable gain would be reported. Elections would not be available in the year of a taxpayer’s death or when the taxpayer ceased to be a resident. If the full proceeds were not reinvested within some reasonable time (say sixty days), a pro rata portion of the gain would be subject to current tax. Income on investments would be subject to taxation, and interest on money borrowed to acquire securities would remain deductible. The plan would be easy for those paying tax and for those who collect it.
Why the Timing Is Right
Several developments suggest that now is the right time:
• The recovery of our oil and commodities strength is likely some years off. Until then, supply will probably exceed demand. We need more strings to our bow.
• Canada has lost ground in some manufacturing sectors. The lower Canadian dollar will help sales, but some lost capacity will not return.
• Recent economic and financial setbacks mean smaller initial revenue losses from deferred capital gains because those gains will likely be smaller for a while. Like infrastructure spending, short-term revenue losses are best seen as a longer-term “investment.”
• The plan will counter weak Canadian business investment prospects by favouring reinvestment from successful ventures over immediate profit-taking. These reinvestments have to succeed to benefit.
• It will make Canada’s capital markets more efficient. People will decide to sell for investment reasons, unaffected by tax considerations. We don’t want our physicians thinking about tax while they operate; similarly with investors.
• The global venture-capital world, one of launching new businesses and moving on from one success to the next, would find Canada a much more attractive place to do that.
The proposal reflects today’s realities, not ideology or theory. Canada has huge advantages – resources, space, water, and food; it’s still the best neighbourhood in the world, with a proven history of mutual accommodation. The best way forward is to make an already-good Canada more competitive for the best people – entrepreneurs, innovators, creators, professionals, scientists, and managers (the weaker dollar is starting to really hurt here). The ability to build personal wealth by keeping one’s gains at work would be an additional powerful magnet, one that is fair and reinforces Canada’s advantages.
The proposal would temporarily “socialize” private-sector gains by keeping them at work creating jobs and wealth and enhancing government revenues. When the reinvestment ends, the deferred tax is paid.
We are likely in the early stages of the second quantum revolution. The first one brought us the modern, digital world. Mike Lazaridis, the technology genius behind the BlackBerry and the Perimeter Institute, the cutting-edge physics research group in Waterloo, Ontario, believes the next one will produce an even greater transformation. He says Canada needs to match a university infrastructure that is strong in basic science research with equal entrepreneurial and investment strength. A one-two punch.
US president Franklin Roosevelt realized that science and the government, together, had contributed enormously to victory in the Second World War. He wanted that same collaboration to bring the US economic success in peacetime by combining effective public support for science with effective incentives to the private sector. Canada, being even more willing than the United States to use collective action to advance shared causes, surely can do this.
After the financial crisis in 2008, Canada had an economic advantage over the United States and other advanced economies that could have lasted a decade. Instead, the advantage has disappeared already because we chose to spend now and earn later, at a record level. Nonetheless, we can have another “Canada moment” when our country is viewed positively from abroad, our economic policy approach is regarded as among the most effective, and Canadians feel deservedly good about themselves.
For two decades after 1945, Canada had a tax policy that was well suited to its strengths. Special provisions encouraged oil, gas, and mining development. The absence of any capital-gains tax proved a driver to all investors and businesses.
These policies rewarded success, not effort; investment, not spending. We again need a custom-made policy for Canada’s particular situation. The controversial report of the Carter Commission in 1966 recommended big changes. One was taxing capital gains as ordinary income – an approach out of tune with how investors and business people behave. This recommendation was rejected in favour of the current 50 percent of gains.
In its December 1970 paper on taxing small business, Ontario accepted that compromise but put the reinvestment-rollover case very simply: “The need for both private savings in Canadian hands and capital-market efficiency strongly favours a reinvestment-related taxfree rollover approach for all shares and business assets … especially if one regards the taxation of capital as more appropriately having a lifetime perspective … The Ontario proposals are based on the central importance of savings and investment for economic growth as the only reliable generator of increased revenues to governments … Ontario does not believe in designing a long-term structure on the basis of short-run revenue considerations.”
Get Moving Now
During his recent “rebranding Canada” trip to the World Economic Forum in Davos, Prime Minister Trudeau offered encouraging words. But now is the time for action, and this proposal responds to Canada’s needs. It is balanced – everyone gains. It will show Canada in a new light, to itself and to others – a unique made-in-Canada way forward.
The Canadian business community has been absent for twenty years from serious discussion of economic policy. It shows. Neither zero federal deficits nor “shovel-ready” should be the primary focus. The business sector should take a hard look at this proposal and consider whether it would work and whether they could help make it happen. The unions should ask if any other proposal would work better for their members. Is there a safer bet for creating good jobs? At Davos, Trudeau said that Canada would not just manage change but take advantage of it. How? Unless matched by some big deeds, the words will not become reality. Small will not work for tomorrow’s world, which is not about to get much better. It will become even more competitive. Mr Trudeau’s assertion will happen only if Canada gets better – starting in Ottawa.
The Right Message
The best global economic outcome is a slow struggle forward to 2020. A worse outcome is where the inclusive global order continues to weaken and Canada becomes more isolated in a difficult economic environment, next door to a United States with a weakening economy and a seriously dysfunctional political system. Canadians must drop their moral smugness and economic complacency and engage in serious discussions about the future. Canada was unprepared for the oil-price collapse. There is no excuse for not being prepared for a wide range of potential economic outcomes in a world that is so uncertain.
There may be a better plan than what I suggest, but doing nothing powerful to stimulate private-sector investment is not an option. The low dollar alone is not sufficient. You do not get ahead by making yourself poorer through foreign borrowing and a currency that buys less. In an outside world that’s far from favourable, how does Canada do something striking and different – really rebrand itself? We need the start of an answer within the year. If we do not, the populism spreading in other Western countries will reach Canada. Too many think the system no longer works for them. The challenge is to find what can work and get it working before the populist train leaves the station.
Postscript
The creation of the federal advisory council guarantees that the government will have the economic discussion it needs (and one ably led by Dominic Barton, a Canadian based in London as global managing director of consulting firm McKinsey & Company). No doubt the council will explore many options before delivering its report, which fortunately is due by the end of the calendar year.
I have believed in the capital-pool approach since 1970, when I was advising the Ontario government in its fight against Ottawa’s tax proposals. I have yet to find a better way forward. We approve of large rewards for sports and entertainment stars because we feel what we give them is matched by what they give us.
The capital-pool idea tries to fit the feeling that “a fair exchange is no robbery” into the broader world of jobs and wealth creation. The idea is win-win – the non-zero-sum world of mutual accommodation, a social contract that works.
* Published in the Globe and Mail, January 1, 2016.
* Published in the Globe and Mail, February 12, 2016.
* Published in the Globe and Mail, February 26, 2016.