We’re going to start with a little history. The chart accompanying this column shows growth in real GDP per capita – how much each Canadian produces, on average, adjusted for inflation – over the past several decades.
From the end of the Second World War until the latter part of the past decade, real per capita GDP increased by nearly 300 per cent, or about 2 per cent a year, from roughly $19,000 (in 2022 dollars) in 1946 to a little under $71,000 in 2017. But since then it has more or less flatlined.
Real GDP per capita
2022 dollars
$70,000
60,000
50,000
Projected
40,000
30,000
20,000
10,000
0
1960
1980
2000
2020
Growth in real GDP per capita
Projected
5.0%
Linear growth
0
-5.0
1960
1980
2000
2020
THE GLOBE AND MAIL, SOURCE: STATISTICS CANADA;
2023 FEDERAL BUDGET
Real GDP per capita
2022 dollars
$70,000
60,000
50,000
Projected
40,000
30,000
20,000
10,000
0
1960
1980
2000
2020
Growth in real GDP per capita
Projected
5.0%
Linear growth
0
-5.0
1960
1980
2000
2020
THE GLOBE AND MAIL, SOURCE: STATISTICS CANADA;
2023 FEDERAL BUDGET
Real GDP per capita
2022 dollars
$70,000
60,000
50,000
40,000
Projected
30,000
20,000
10,000
0
1960
1980
2000
2020
Growth in real GDP per capita
Projected
5.0%
Linear growth
0
-5.0
1960
1980
2000
2020
THE GLOBE AND MAIL, SOURCE: STATISTICS CANADA; 2023 FEDERAL BUDGET
What had previously been a long deceleration in growth has become a long period of no growth: Real per capita GDP is no higher now than it was in 2017. True, there was a pandemic in the interim. But the trend predated the pandemic. And it seems likely to continue for some years after.
This week’s federal budget projects real growth averaging a little over 1.6 per cent per year over the next five years. But our population is growing at about the same rate, maybe even faster. Result: Real per capita GDP in 2027 will still be lower than it was in 2017. As it will remain, perhaps, for some years after that. You have to go back to the 1930s to find a comparable period of stagnation.
The implications should be obvious. Per capita GDP isn’t just the foundation of living standards, and the deeply ingrained popular expectation that these should rise over time. It’s also the basis for funding social services, notably health care: now consuming nearly 50 per cent of provincial own-source revenues. As the population ages, and the ranks of the elderly mount, health care costs will soar even further. If incomes remain flat, the prognosis is grim.
So the problem of sluggish growth is no longer just a problem: it is becoming something of a crisis. A decade or more with no growth in output per capita was not something that was supposed to happen.
As I suggested in my last column, there are two broad approaches to improving the economy’s long-run growth potential.
The first starts with the recognition that the key to raising productivity and growth is to generate higher rates of investment. How to raise investment? By reducing the barriers to investment, notably high rates of taxation on capital income.
(This is mostly a matter of arithmetic. Say an investor needs a 10-per-cent after tax rate of return to justify investing in a given project. At a 50-per-cent marginal tax rate, the project would need to earn 20 per cent before tax to meet that test. But at a 33-per-cent rate of taxation, it would only need 15 per cent. Cut taxes from 50 per cent to 33 per cent, then, and a bunch of investments paying 15 per cent to 20 per cent before tax that would not previously have been green-lighted suddenly become viable.)
Of course, part of keeping taxes low is to keep government spending and borrowing low, so that investors can make decisions secure in the knowledge that they will not be hit with unexpected tax increases in future, by a government desperate to stave off its creditors.
The second part of this approach starts from another key recognition: that people make better decisions about how to use scarce resources when they know what things cost. So it favours accurate price signals, undistorted either by subsidies or regulations.
And the third part of this approach starts from the recognition that even with accurate information and lower taxes, people still won’t necessarily take the risks and disruption that go with any attempt to meaningfully improve productivity unless they have to: unless they are in fear that their competition will eat their lunch if they don’t. So it favours maximizing the free play of competition in the economy, without attempts to protect one sector or another.
What, instead, is the approach this government has taken, and on which it has doubled down in the budget? It is to raise taxes, to raise spending and to raise public borrowing to new heights. And – the budget’s centrepiece – it is to shower businesses with generous investment tax credits (15 per cent to 40 per cent!), provided they invest in certain types of things: electricity, hydrogen and other “clean” technologies.
The effect of such subsidies (and yes, that’s what they are: just because they’re delivered through the tax system doesn’t alter the basic dynamic) is both to preserve companies from having to pay the full costs of things and to shield them from competitors. This distorts the allocation of productive resources: decisions about investment are made, not on the basis of the underlying economic fundamentals, but in pursuit of the tax credits.
There is no particular reason to imagine people in government are better placed than others to discern future trends in the economy: which firms will succeed, which industries will thrive, which technologies will change the world. If they can see what’s coming, so can private investors, whose livelihoods depend on it.
In sum: If an investment is economic, it doesn’t need a subsidy. If it isn’t economic, it shouldn’t get one.
All of this is well known. Indeed, the budget makes a show of disdaining traditional “industrial policy,” even as it is going all in on it. “This approach is not about the government picking individual corporate winners,” the budget reads, “in an effort to engineer a preferred vision of the economy in 2050.” Rather, it is “designed to set a framework for boosting overall investment, while leaving the private sector to determine how to invest based on market signals.”
But it’s not about boosting overall investment: if it were, the tax credits would apply universally. Or the government could just cut tax rates. Far from leaving market signals to guide private sector investment decisions, the budget very deliberately tilts the pitch in favour of certain sectors, certain technologies and, inevitably, certain companies.
(That’s implicit, in the case of the tax credits, since some companies will be better placed to take advantage of them than others, and explicit, in the case of the government’s large and growing portfolio of public investment funds. As on other points, the budget appears to be at war with itself here.)
The argument appears to be that Canada must subsidize these industries because the United States has done so, via the notorious Inflation Reduction Act. It’s the same argument you hear made for more bespoke subsidies such as the billions of dollars (we still don’t know how many) handed to Volkswagen to persuade it to locate an electric-vehicle battery plant in St. Thomas, Ont. If we don’t, others will.
This would be a good argument if we lived in a world without scarcity or opportunity costs. If there were no cost to matching other countries’ subsidies, why wouldn’t we? But there is a cost. There’s a cost to the government: The money spent on subsidizing industry is money that can’t be spent on other things.
And there’s a cost to the economy – the opportunity cost. Any time you subsidize one firm or industry you are implicitly penalizing others: the ones that aren’t subsidized. Subsidies don’t create jobs and investment out of thin air. They simply drain labour and capital from other sectors. We see the jobs and investment that subsidy “saves.” We don’t see the jobs and investment that are destroyed in the process.
It isn’t the Americans that those subsidized industries and firms are competing with. It’s other Canadian industries. So the argument that Canada must subsidize electric-vehicle batteries and other green technologies to “keep us in the game” vs. the Americans amounts to arguing that the subsidized Canadian industries are more important than the others. Indeed, they are all-important. They are industries, as it is often said, that Canada must be in. No matter what the cost.
The irony is that this almost religious conviction is usually offered up in the name of pragmatism. Be practical, its proponents will say. If other countries subsidize their industries, we have to do the same. No: we only have to if you accept that we have to be in those industries.
There might be a case for matching subsidies, even so, if one of two things were likely to happen. If by subsidizing our industry we were to knock all the other players out of the ring, obtaining a worldwide monopoly on the product in question, that might (on a lot of other assumptions) earn such enormous profits for the Canadian contestants as to make the game worthwhile. Or, if subsidizing our industry were likely to persuade the United States and other players to stop subsidizing theirs, that might also (again, on certain assumptions) be worth trying.
But neither of those scenarios are in play here. We’re not going to knock the Americans out of the ring, and we’re not going to stop them from subsidizing their industries. The only thing subsidizing our industries is going to buy us is the right to go on subsidizing them. In perpetuity. We’ve seen this movie before: with the auto industry, with the aerospace industry, with the movie industry for that matter – industries we had to be in, no matter what the cost.
That is what the government is now plunging us into with respect to the “clean” technology sector. The cost, as astronomical as it is – nearly $6-billion annually, within a few years – is likely to be much greater than that. It will be greater because, if experience teaches us anything, the deeper firms get into the subsidy trough, and the larger they grow, the more dependent they become on it – and the greater the political cost to the government of cutting them off. (Supposedly the tax credits will end as of 2034. Don’t bet on it.)
And it will be greater because the availability of such rich, open-ended subsidies is likely to attract a lot more take-up than the government assumes – not all of it involving the actual manufacture of anything. Tax lawyers and accountants do this kind of thing in their sleep.
That, I fear, will be the legacy of this budget: the creation of a number of large and permanent subsidy sinkholes to further disfigure the Canadian economic landscape. And all in the name of the environment.