On a video call last week, Chrystia Freeland sat and listened while the country’s top private-sector economists told her what was missing from her $101-billion stimulus plan.
It certainly wasn’t size. Some of the experts at the virtual table convened by the Finance Minister warned that the government was in danger of overstimulating the recovery. Others said Ottawa would need to be very disciplined indeed to put the spending genie back in its bottle and tame debt over the next several years.
What was missing, participants told Ms. Freeland, was balance. The plan, they argued, tilts too much toward fuelling demand in the economy, and not nearly enough to measures that would stimulate supply.
In doing so, the postpandemic recovery package neglects a chronic weakness in Canada’s economy that could really use some serious help – namely, business investment. And in the more immediate term, it ratchets up the risk that fiscal policy will contribute to an overheating of a recovery that is already seeing pockets of demand racing ahead of producers’ capacity to meet it.
The budget and its stimulus plan certainly didn’t ignore measures to fuel growth in labour supply (most notably, the national child care plan) and small-business investment and innovation (such as the Canada Digital Adoption Program). But the vast bulk of spending in the package over the next year continues to be targeted at wage subsidies and income supports for workers and employers hit by COVID-19 shutdowns and restrictions. The effect of these programs is, ultimately, to keep money flowing into consumers’ pockets – which keeps consumer demand humming.
We have already seen how these supports over the past year have turbocharged the demand side. In March, Canadian retail sales were up 11 per cent from their prepandemic level – in an overall economy that was still operating below where it had been before the crisis. Total household disposable income jumped 10 per cent last year.
Household savings have swelled during the pandemic, to the tune of roughly $100-billion of excess cash in bank accounts. The government itself has called this a “preloaded stimulus” that could, potentially, unleash a torrent of pent-up demand as the economy gradually reopens in the coming months.
The other side of the equation – adding supply capacity – has not kept pace. It has headed in the wrong direction. Business capital investment (excluding residential construction) fell 12 per cent last year. Spending on machinery and equipment slumped 18 per cent.
With so much juice already in place on the household demand side, some economists had urged Ms. Freeland in advance of the budget to focus her stimulus on kick-starting business spending – something along the lines of temporary government subsidies for capital investments. It didn’t happen.
As the C.D. Howe Institute noted in a report this year, Canada was already a laggard in business investment, behind the United States and most other advanced economies, before the pandemic. C.D. Howe chief executive officer Bill Robson, the co-author of the report, said that Canada’s stock of business capital per worker has been falling for five years, “with the gap widening during the COVID-19 crisis.”
That trend is, unquestionably, a longer-term threat to Canada’s business competitiveness and its economic potential. It certainly deserved bigger attention in this budget from a government that has repeatedly billed its postpandemic economic recovery philosophy as “building back better.”
In the more immediate context, this imbalance between demand and supply stimulus is a key element in the question of whether fiscal policy threatens to overstimulate the economy as the recovery gains momentum.
A better balance would imply spending that would contribute roughly equally to increasing both demand for goods and services, and the economy’s capacity to meet that demand. That would give the economy more room to absorb the government investment, and raise the bar for the growth the government is trying to promote.
But by heaping the fuel on demand, without matching it with new supply – well, that’s pretty much the recipe for overheating. Which, in turn, is a recipe for inflation.
Last week’s Canadian inflation figures for April already showed pockets of rising price pressures where surging demand was being squeezed by supply-chain bottlenecks. While it would be a big stretch to call these pressures widespread, we are seeing early warning signals that the supply side may face serious challenges meeting the coming resurgence in demand as the pandemic winds down.
Ms. Freeland’s response to the economists’ concerns, apparently, was that Ottawa expects the big boost in demand to spark the desired acceleration of business investment. If it happens the way Ms. Freeland and deputy finance minister Michael Sabia have drawn it up, the supply side will get its lift without the government having to spend more to bribe business with subsidies or tax cuts.
But with demand already racing ahead of supply in some corners, the stakes in this leap of faith are growing. It’s going to take some time for business investment to catch up. In the meantime, the tilt in fiscal policy may continue to turn up the pressure.
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