Posted on November 11, 2011

Lucky to Be Canadian

With the rise in the unemployment rate to 7.3% and first half growth of a mere 1.6%, along with increasing global financial uncertainty, there is no need for Canada to mindlessly follow an austerity plan that was developed when the economy was expected to grow at a relatively strong pace. Bank of Canada Governor Mark Carney recognized months ago that Canada’s recovery is dampened by the much weaker-than-expected U.S. economy and the enlarging effects of the Euro crisis. Canadians have benefited throughout this period from the fiscal reforms so painfully enacted in the early-to-mid 1990s.

In addition, the Bank of Canada successfully broke the back of inflation in the early ‘90s and has warranted its global credibility since that time. Our banks and other financial institutions have earned the title of the ‘World’s Strongest’ through our prudent and principles-based supervisory and regulatory system. And, our housing market was never exposed to the excesses of sub-prime lending and collateralized debt obligations so explosively prevalent in the U.S. in the boom years prior to the 2008 collapse. Canada is also advantaged by our rich endowment of natural resources that fuels the rapid growth of the emerging economies. Nevertheless, we are an open economy intrinsically impacted by economic, political and financial turmoil in the rest of the world. It is prudent for us to maintain an open-minded and flexible stance on countercyclical monetary and fiscal policy. We have struck the right balance, in my view, on both.

Our corporate tax rates are the lowest in the G7 and amongst the very lowest in the OECD. Entrepreneurship is thriving in Canada, although much can be done to develop a deeper venture capital market. Private sector research, development and innovation are key to our future prosperity as public/private partnerships between universities and hospitals and the business community are already bearing fruit in developing and commercializing research and innovation breakthroughs. Of course, much more needs to be done in this area and Canada should continue to encourage the in-migration of young talent from the rest of the world. In the meantime, though, the U.S. is mired in a never-ending election cycle that has created a dysfunctional stalemate between competing parties. The so-called Supercommittee of Congress is unlikely to achieve a substantial compromise proposal as the U.S. Thanksgiving deadline looms less than two weeks away.

Lack of compromise would force an automatic severe cut mainly in defence spending, adding to the already-large layoffs in the noncivilian sector and negatively impacting government suppliers which include a significant number of Canadian companies. Moreover, the U.S. housing market continues to flounder, keeping the contractionary pressure on Canadian exports of lumber and other building products. The Euro Crisis has its negative impact on Canada as well. Certainly the selloff in stocks, market volatility and the sideswiping impact on our bank stocks unnerve investors, cause large losses in private and public pensions, and discourage businesses from investing and hiring for the future. Consumer confidence, though well above that in the U.S., has been weakened by the global uncertainty, making many feel vulnerable to further potential bad news. The crisis in Europe is far from over. As technocrats take over the helms in both Greece and Italy, there is greater hope for unpopular government and labour reforms. But other measures are urgently needed, including the recapitalization of European banks, the broader role of the ECB and the dramatic enlargement of the resources available to the bailout fund (the EFSF). Contagion is a fact; bankrupt Greece will certainly default on its debt and the contagion is manifest by the recent surge in Italian interest rate spreads. Those spreads have temporarily come in with the forced exit of Berlusconi and the ECB’s purchases of Italian bonds, which contributed to this week’s successful Italian bond auction. But, this is no more than another stopgap measure to temporarily keep the dyke from breaking. Last week’s ECB rate cut under the new leadership of Mario Draghi was a very welcome and dramatic turnaround from the misguided monetary tightening of former ECB President Trichet. Hopefully, this will be a first step in additional monetary easing as Europe is uncomfortably close to recession. Austerity programs in most of Europe have weakened economic activity and raised the jobless rate, reducing tax revenues and exacerbating the deficit and debt problems. In some case, especially in the peripheral economies of Europe, broad-based government and labour reforms and asset sales are essential—Greece and Italy of note. But immediate fiscal drag is threatening recovery in France, the U.K., and even Germany, not to mention the U.S. President Obama’s jobs recovery proposals are still struggling to get Senate approval and a watered-down version is all that is likely to be legislated.

Bottom Line: We are lucky to be Canadian. And all the more so because we are in a position to ‘keep our powder dry’ in the event that further countercyclical stimulus is needed. Unlike most other developed economies, we have some ammo left and the good sense to know when, and if, to use it.