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Economic Outlook: Saving, Investment and Productivity Growth
GDP per Capita and Productivity Growth: A Look Back
Since 2006, the year before the onset of the Global Financial Crisis (GFC), real GDP per capita in Canada has grown at an average annual rate of 0.4%, well below the average of 1.6% of the prior years. Cumulatively, since 2006, our real income has grown by a disappointing 5.4%. On the trend of the prior 30 years, it would have risen by 35%.
The world has changed since 2006. We went through and recovered from not only the GFC, but also COVID. We signed trade agreements with European and Asia Pacific partners, renegotiated the North American Free Trade Agreement (NAFTA), then saw globalization stall in its tracks. We traded our Blackberries for iPhones and then witnessed the emergence of artificial intelligence (AI) partly pioneered in our own institutions. Start-ups emerged, some grew, many disappeared. Energy markets were transformed by the shale revolution and by policy to address climate change. Canadian oil production and exports expanded, we retired most of our coal plants, and we invested more in renewables. Our population grew older and we bolstered our immigration intake. Consumption and housing stayed robust, aided by rising levels of household debt. Governments broadly expanded programs and services. They borrowed, including to build infrastructure in response to the GFC, and then massively to fund transfers to individuals and loans to businesses during COVID. Inflation re-emerged and central banks around the world responded by tightening monetary policy. Geopolitical tension and wars brought national security and economic security into sharper focus.
Through the period, public and private debt rose, the Canadian current account went from a small surplus to a small deficit, and we redistributed large shares of income. Yet, per person, after inflation, we grew our economy by only 5.4%.
For sure, Canada is not alone in having experienced a slowdown of growth. The phenomenon is worldwide. However, other developed economies performed substantially better. From 2006 to 2023, real GDP per capita rose by 10.4% in Japan, 11.8% in the euro area, 19.6% in Australia, and 21.4% in the United States. The U.K., at 7.9%, is closest to Canada.
In addition to demographic and labour market changes, the major factor explaining the slowdown in GDP-percapita growth is weaker productivity growth. GDP per hour worked in the business sector in Canada in Q1 2024 was 10.9% greater than in 2006; on the earlier trend, it would have been 28.9% greater. The slower productivity growth in the economy, in turn, is explained by lesser capital deepening—that is, lesser increases of capital (such as structures, and machinery and equipment [M&E]) per unit of labour. Importantly, both before and after the GFC, there was little contribution to productivity growth from better use of capital and labour, what economists call multifactor productivity, a rough proxy for innovation.
The Determinants of Productivity Growth: How We Measure Up
Compared with other countries, in aggregate our saving and investment as a share of GDP is roughly average. However, we allocate a larger share of our national saving to investment in housing, even when accounting for population growth.
Per worker, we invest more in non-residential structures—for example, energy infrastructure—than most other developed economies, although substantially less than Australia. By contrast, our economy invests materially less per worker in M&E and intellectual property products (IPP) than most peer economies, and far less than the United States. For example—unlike in the United States—our businesses, in aggregate, did not ramp up investment in information and communications technology (including software) through the period of recovery from COVID.
To restore stronger growth in GDP per capita and to improve standards of living, our economy needs to invest more per worker and to innovate faster in the use of capital, technology and labour.
The Global Conditions: Fragmentation and Structural Change
Admittedly, global conditions do not appear particularly hospitable to business investment. The world is fragmented and beset by uncertainty. It is characterized by:
- geopolitical tension and a realignment of supply chains;
- trade friction and a rise of protectionism, including as may intensify in North America with a review of the Canada–U.S.–Mexico Agreement (CUSMA) in the offing;
- a baseline projection of modest growth of global demand for the medium term; and
- pressure on costs that, together with high levels of debt, are likely to keep real interest rates higher than pre-COVID even once inflation is back to target.
Globally, and in Canada, the policy signals affecting the energy transition and the digital transformation of our economies, two critical drivers of new investment, are uncertain. On energy and climate, while the direction is clear, policy is running ahead of markets: private investment is not matching what would be required to meet policy goals and commitments. By contrast, as regards digital technology and AI, policy is trying to catch up to markets. Investment must take into account a complex and evolving set of rules and standards.
These factors together pose significant risks and raise a wide range of plausible scenarios for the medium term. Some of the developments may depress investment. Yet, structural shifts and disruption also create opportunity. To be on the winning side of change, businesses have to make calculated bets and move forward with long-term strategies and investments.
Canada has assets and cards to play in global competition. And there are positive recent developments. The Trans Mountain Expansion pipeline is now in service. The Canada LNG project is well advanced. We have secured, at a cost, landmark investments in the battery and electric vehicle supply chains. There is world-class talent and a vibrant universe of start-ups at the leading edge of AI technology. Yet, there is much more to do just to keep up with global competition, let alone beat it.
A Baseline Scenario to the End of 2026
To assist business planning, we provide a baseline scenario for growth, inflation and interest rates for the United States and Canada to the end of 2026.
After diverging during 2023, the two economies are both projected to grow at an annual rate of about 2% through to 2026. We expect the U.S. economy to again rely on productivity improvement to achieve the projected 2% growth more heavily than in Canada where, as in the past, additional hours of work (i.e., more labour) are likely to play a more important role.
We expect inflation to reach the 2% target in Canada by the end of 2025 and in the United States by early in 2026. The Bank of Canada has begun cutting its policy interest rate, and the Federal Reserve is expected to follow in the second half of 2024. The Bank of Canada should make one or two additional quarter-point cuts by the end of the year. We think that the Fed is likely to cut once, by a quarter point, by year-end. Under our scenario, the policy rates in the two economies will be reduced at different paces, but to the same floor of 3.0% to be reached early in 2026.
We see long-term interest rates (i.e., 10-year government bond rates) remaining somewhat below 4.0% in Canada until the end of 2026, and in the United States trending down to the same level over the period.
The Overriding Economic Policy Goal: Raising Productivity Growth
To continuously improve our standards of living, the overriding goal of economic policy for Canada must be stronger growth in productivity. It is by giving productivity enhancing investment absolute priority that Canadians may continue in the future to have the income—and governments the revenue—to buy desired private and public goods and services, and to advance other critical pursuits.
Raising the share of GDP allocated to saving and investment today and in the medium term implies that a reduced share is available for current consumption. For households, this means increasing saving in some form as a share of current income. For businesses, it entails the reinvestment in productive capital of a greater share of earnings. For governments, it means allocating proportionately more resources to public investment that can generate a future stream of income, rather than enhancing current transfers.
A strategy that is laser-focused on productivity growth must have a medium-term horizon. It must give direction, predictability, consistency and coherence to the actions of government, and thus provide clear signals to investors. Investments in energy and resource infrastructure, as well as in research and development (R&D) and innovation, require a consistent policy framework that extends well beyond any political cycle. Details of that framework will evolve, in particular to respond to global developments, but there must be solid medium-term policy principles and anchors.
There is a role for every level of government in establishing the policy framework to raise Canada's productivity growth, and there should be both collaboration and accountability. The federal government has powerful levers, and it can exert national leadership. Yet, provinces, territories and local governments, and in some cases Indigenous governments, are on the front lines of policy development and especially delivery in key domains, and there must be some alignment of strategy, plans and actions.
Governments must have a credible medium-term fiscal framework under which promised services are realistically budgeted for and paid for from current revenues. While fiscal policy continues to have an important stabilization role, net borrowing over the cycle should be undertaken for the sole purpose of funding investments that grow productive capacity and yield an identifiable stream of revenue. A productivity focus by government also entails more attention to execution and delivery, the complex implementation work that comes after the policy announcements.
As technological and economic conditions evolve, productivity growth is achieved by the reallocation of resources—financial capital, skilled labour and leadership—to the most innovative and successful activities and enterprises, and away from less productive ones. Economists refer to this healthy process as one of "creative destruction." Governments must have a tolerance for disruption and a capacity to facilitate the adjustment of workers.
Federal and provincial governments, individually and working together, have to address all of their policy initiatives through the lens of productivity enhancements, designing their policies and programs in such a manner as to create a framework that best serves this overriding goal.
Domains of Priority Action for Governments
In our last Economic Outlook, we identified five domains of policy priority: immigration, competition, taxation, frameworks for the digital economy and environmental regulation. All remain salient.
For example, on immigration we underscored the need to attract highly skilled individuals who can help raise output per worker, and to resist pressure simply to close gaps in low-paying occupations.
On taxation, a succession of recent federal measures illustrates the need for a coherent, integrated approach. We do not advocate a one-shot all-encompassing reform. However, there is a need for a continuing, stepwise effort, with annual instalments, founded on clear principles and with a focus on stimulating saving and risk investment.
There is a case also to review aspects of financial sector regulation to determine how more of the saving of Canadians can be channeled efficiently to productive investment.
At a difficult time for global economic relations, the federal government has a critical leadership role in positioning our economy internationally and working with provinces and businesses as Team Canada to manage risks and advance our interests.
Securing our relationship with the United States is top of mind. CUSMA was a success for our economic diplomacy. The next rounds—under any administration—may be more difficult. Managing our relationship with China while also building viable and resilient supply chains in North America, notably in electric vehicles (EVs), will be an equally delicate task. Broadly, we must find our way in a more fractious world without succumbing to protectionism, which would deeply damage our economic prospects.
The Important Role of Provinces
Provinces are key players in support of some of the priorities cited above. For example, under Canada's 2024–2026 Immigration Levels Plan, 40% of economic immigrants will be admitted to Canada under the Provincial Nominee Program.
On all forms of regulation, provinces and municipalities loom large. Provinces are in the driver's seat on internal trade. The International Monetary Fund (IMF) in 2019 estimated that "complete liberalization of internal trade in goods could increase GDP per capita by about 4 percent." Progress to date has been glacial.
We cite two domains where provinces have the lead and where decisive action could accelerate the building of a clean, productive economy.
- The first is the expansion and decarbonization of the electricity grid. Under most estimates, a clean economy by 2050 requires doubling or more the capacity of our electricity system, including clean generation and transmission. Given long lead times to plan and execute investments, and the massive scale of the enterprise, the signals to public and private investors must be very clear. The federal government has introduced some policy instruments to support the effort. Provinces must drive planning and execution as a matter of priority.
- The second is industrial carbon pricing. It is the part of the carbon-pricing system that is expected to make the largest contribution to emissions reductions. Yet, the provincial systems are disconnected, even where the federal backstop applies. It is entirely within the authority of provinces to collaborate toward a harmonized and integrated system that would facilitate compliance, allow the trading of credits across the country, incentivize investment, and help achieve emissions reductions at the lowest cost.
In Sum
There is no single federal or provincial policy or set of policies that, all else unchanged, could alter decisively and quickly trends in saving, investment and productivity growth.
Moving the needle will take time, and it will require a coherent and complementary set of actions by federal and provincial governments working together with businesses.
Overall, both business strategy and government policy must converge toward raising output per worker and GDP per capita. If, alternatively, this goal is subsidiary to all other important pursuits, then we will be dividing a static or shrinking pie and likely falling further behind other nations.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.