After a pretty good year for economic growth in 2017, the Canadian economy has settled back into a world of modest, even mediocre, annual growth of 2 per cent or less. The United States is having a good year in 2018, with growth pushing 3 per cent, in part due to the short-lived impact of tax reform. However, U.S. growth is also projected to moderate hereafter. North America is not alone; mature economies such as Japan and Western Europe face a prolonged period of tepid economic growth. Even China is facing a growth slowdown after three or more decades of often-spectacular economic performance.
There are tangible consequences to a world of slower growth and no easy ways to promote faster growth in the years ahead.
Why are we stuck in a world of mediocre growth? There are immediate, cyclical and structural reasons. Most discussion focuses on the current conditions, notably the uncertainty caused by the turbulent and protectionist trade agenda of U.S. President Donald Trump. The combination of unjustified tariffs and an aggressive campaign to alter or oppose free-trade agreements has threatened supply and value chains, and unsettled investors in major trading partners. Even the successful resolution to the contentious renegotiation of the North American free-trade agreement will provide little or no positive boost to growth.
Next, North American and global business cycles have entered a more mature phase after nearly a decade of unbroken growth. Until recently, economies in many countries were still healing from the global financial crisis, relying heavily on monetary morphine – exceptional policy intervention by central banks and prolonged low interest rates – to keep moving forward. Rising interest rates today are a sign that things are returning to normal, but also mean the period of easy money and debt-fuelled growth has come to an end. Canada relied heavily on consumers and personal debt to drive its economy over the past decade; higher interest rates will steadily raise debt service charges and squeeze the capacity of many consumers to keep spending.
Moreover, irresistible demographic forces have dragged down what economists call “potential,” or the sustainable growth path for the economy. An aging population means more people retiring, fewer labour-force entrants and slower overall growth in the work force – which limits the economy’s sustainable capacity to grow. The new normal for Canada is growth of 2 per cent or less, and U.S. potential is only slightly higher. Steps can be taken to partly offset this structural reality, such as attracting more immigrants, keeping older workers longer, engaging underrepresented groups and upskilling current employees, but the forces of aging demographics are very hard to resist.
One obvious effect of mediocre growth is a squeeze on public finances. Slower growth combined with low inflation means slower growth in government revenues; yet, pressure is unrelenting to spend on valued public services such as health care and modernized infrastructure. Provincial governments in particular face acute fiscal pressures, but many have inadequate revenue bases.
The federal Parliamentary Budget Office recently reported that for subnational governments as a whole, current fiscal policy is not sustainable over the long term. Only Quebec was judged to have an adequate fiscal plan. The territories, Newfoundland and Labrador and Alberta reportedly have the largest current fiscal gaps. As the PBO dryly put it, policy actions at the subnational level, such as reductions in program spending, higher taxes and/or increased transfers from the federal government, would be required to close these gaps.
Breaking out of the mediocre-growth trap is very hard to do. Economists have been moaning about Canada’s poor productivity growth (at its simplest, output per hour worked) for decades. Some necessary steps for faster productivity growth have been taken, such as repeated efforts to reduce internal barriers to commerce, but with little apparent effect. Canadian immigration levels have already been increased to about 300,000 people annually, or nearly 1 per cent of the country’s population – but that alone will not offset the impact of aging demographics.
Other transformational, pro-growth policies could be considered – including things such as a fundamental rethink and modernization of tax policy, a massive rebuild of Canada’s infrastructure or accelerated low-carbon transformation and investment. But let’s be frank – political conditions for bold transformation generally don’t exist today in Western democracies. (Perhaps a one-party state such as China can think and operate in transformational terms.) Indeed, the populist pushback in some Western democracies makes a step backward as likely as steps forward on rebooting the economy’s underlying growth potential.
If mediocre growth is now the norm, and policy transformation is hard to achieve, where does that leave us? The alternatives should still be examined by think tanks and advanced by policy-makers who can keep pushing forward with small increments rather than hoping for a big bang. Defining the best policy options is still important work, if and when the right political conditions emerge. But in the interim, public expectations are going to have an encounter with reality.
Glen Hodgson is a senior fellow at the C.D. Howe Institute.