The 12 key economic challenges facing the next government

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Canada’s next government will have to address a daunting set of economic challenges – some new, some familiar to a pandemic-weary country, some seemingly intractable. Crucial decisions about the future of energy, trade and the digital economy will have to be made against a backdrop of mounting debt and persistently high inflation. Here are the key economic issues the incoming government will face.

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The recovery

The most pressing economic issue remains the pandemic. The high rate of vaccination in Canada has allowed businesses to reopen over the summer, with workers preparing for a return to the office this fall. But the Delta variant of the virus is creating uncertainty. Alberta, the province that was the furthest along in loosening pandemic restrictions, declared a health emergency last week and reintroduced strict measures to fight the virus.

The Canadian economy has rebounded since the spring of 2020, when the first round of lockdowns and plummeting oil prices caused the sharpest contraction in history. But there are still 156,000 fewer jobs than in February, 2020, and recent Statistics Canada data show the recovery may not be as far along as previously thought. Meanwhile, COVID-19 continues to disrupt global supply chains, pushing up shipping prices, making it hard to source manufacturing inputs and weighing on exports.

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The most important public-health decisions will continue to be made at the provincial level. But the incoming federal government faces crucial choices about border restrictions and vaccination requirements, most notably for transportation. It will also have the delicate task of winding down support for businesses and individuals – moving from broad-based relief to targeted support for the hardest-hit sectors – without triggering a wave of bankruptcies and layoffs. – Mark Rendell

Jobs

Canada’s labour market is in a strange situation. It’s still a long way removed from a full recovery, needing hundreds of thousands of people to get back to work. But companies say they’re struggling to fill positions. Discussions about low-wage work, and the degree to which pandemic income supports are skewing incentives, tend to obscure a persistent issue for employers: skills shortages.

Small businesses say the No. 1 thing holding back sales and production is a lack of skilled labour, according to survey results from the Canadian Federation of Independent Business. That’s a typical response that predates the pandemic and will likely outlast it, too. A recent Royal Bank of Canada report estimated more than 700,000 skilled tradespeople are expected to retire by 2028. Some of the worst shortages, the report said, will be for industrial mechanics, boilermakers and welders – key roles in revitalizing the country’s infrastructure. Furthermore, the pandemic has highlighted another long-standing shortage: nurses. As of June, there were about 109,000 vacancies in health care and social assistance, a sector that often has the most unfilled positions. Canada will need a bold policy prescription to ensure it has enough people in the right jobs. – Matt Lundy

Public debt

Government support for individuals and businesses during the pandemic led to an unprecedented surge in public debt. After running a $335-billion deficit in the previous fiscal year and a projected $138-billion deficit this year, federal debt is expected to approach $1.2-trillion this year, about 48 per cent of gross domestic product, according to Parliamentary Budget Officer estimates. None of the major parties has pledged to rein in spending significantly or raise taxes substantially.

With interest rates at record lows, the cost of servicing the growing debt load remains manageable, particularly when compared with the debt scare of the 1990s. But interest rates will inevitably rise in the coming years as central banks push back against inflation and withdraw stimulus. That will increase debt-servicing costs as bonds roll over.

Furthermore, all the parties are relying on optimistic economic growth projections to shrink public debt relative to the size of the economy over time. Robust growth is not guaranteed, particularly as the population ages and Canada continues to struggle with low productivity growth. As Bank of Montreal chief economist Douglas Porter put it in a recent note to clients: “Governments not repairing finances now, during an economic recovery, could leave them woefully vulnerable to the next major challenge.” – Mark Rendell

Inflation

Inflation hit an 18-year high of 4.1 per cent in August, fuelled by business reopenings, supply-chain disruptions and prices bouncing back from last year. Central bankers argue inflation will come down once supply chains normalize and “base year” effects dissipate. More skeptical economists point to the huge amount of fiscal and monetary stimulus during the pandemic to suggest price pressures will remain elevated for some time.

The Bank of Canada has stressed patience, saying it won’t raise interest rates until the labour market has healed and the country’s economic output is back to normal – something it doesn’t see happening until the second half of 2022. But after five months of inflation running above its 1-per-cent to 3-per-cent target range, the bank may be rethinking its timeline for removing stimulus and raising rates.

Governments typically avoid commenting on central-bank decisions. However, the bank’s five-year mandate is up for renewal this year, giving the incoming government an opportunity to weigh in on the overall direction of monetary policy. At issue is whether to maintain the existing inflation-targeting regime, in place since the 1990s, or move to something like a dual mandate, which would target full employment alongside price stability, or a system that would aim for higher inflation coming out of recessions. – Mark Rendell

Housing

Housing affordability became a campaign topic against the backdrop of a real-estate frenzy, but the problem has been building for years. The key issue is supply: Not enough homes are being built to keep pace with population growth, especially in major cities such as Toronto and Vancouver. Jean-François Perrault, the chief economist with Bank of Nova Scotia, estimates Canada has the lowest number of housing units for every 1,000 residents of any Group of Seven country.

The federal government has few direct levers to deal with the supply problem, as most land-use and development decisions rest with municipalities and provinces. It can, however, encourage lower levels of government to speed up construction by tying federal funds to housing densification and pro-construction land-use policies.

Demand-side interventions are more controversial. Various parties proposed putting more money in the hands of first-time homebuyers and reducing their monthly mortgage and insurance costs. Housing market experts say these plans are counterproductive: Measures that make it easier to take on debt will fuel the run-up in prices and counteract regulatory interventions, such as stricter mortgage stress tests. As Evan Siddall, the former head of Canada Mortgage and Housing Corp., remarked on Twitter: “It may be good politics but it’s irresponsible policy.” – Mark Rendell

Climate

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The next cabinet will be sworn in just weeks before the start of COP26, a landmark United Nations climate conference that is supposed to set the course for collectively working to reduce global greenhouse-gas emissions.

Ottawa has already submitted to the UN a new emissions-reduction commitment of 40 per cent to 45 per cent below 2005 levels by 2030. (The Conservatives campaigned on returning to the previous 30-per-cent target.) But Ottawa still needs to work quickly to prepare for negotiations around new international policy mechanisms. That may include tariffs on some carbon-intensive imports, known as carbon border adjustments, which all the major parties say they are interested in implementing – but without really explaining how they would do so.

Meanwhile, to get Canada on track to meet its emissions-reduction target, the government will have to move swiftly to develop an array of new programs promised during the campaign, including a new sales quota and other measures to speed the transition to electric vehicles; an expanded strategy for retrofitting buildings; and new tax credits for carbon capture and other forms of clean technology.

And after a summer of deadly heat waves and natural disasters, the government will need to prioritize building resilience to unavoidable climate-change effects. That will involve making good on commitments such as new funding to fight wildfires and ensuring the availability of flood insurance for high-risk homes and businesses. More broadly, it will mean completing work on a new national adaptation strategy that was in the works when the election was called. – Adam Radwanski

The future of energy

In just more than half a decade, Canada’s energy sector has been decimated by existential forces, including a price slump, a pandemic and environmental pressures that combined to sap its finances and force thousands of people out of their jobs.

Now, after a summer of heat waves, wildfires and destructive storms, oil and gas companies find themselves in a tougher struggle to convince investors and the general public that they are serious about reducing their emissions in the transition to a low-carbon economy – and that they can do it while supplying new markets.

The International Energy Agency and the UN Intergovernmental Panel on Climate Change issued reports this year detailing the extent of the crisis and the need to slash greenhouse-gas emissions from fossil fuels. The IEA laid out a roadmap to net-zero emissions that prescribes no spending on new oil and gas fields.

Canada’s biggest energy challenge remains Alberta’s oil sands, which generate almost 12 per cent of the country’s CO2 emissions. To survive, the industry must somehow show it is reducing its impact while making a case for more pipeline capacity to a carbon-constrained world.

The oil sands’ biggest players have pledged to get to net-zero emissions by 2050, and that will mean massive investments in new technology and offsets in the form of carbon capture and renewables. A big question for Canadians is how much taxpayer money should go into the effort as the world shifts to greener energy sources. – Jeffrey Jones

Reconciliation

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When the Mi’kmaq First Nations Coalition announced last year that it was buying 50 per cent of Clearwater Seafoods in a $1-billion deal, one of the parties most pleased with the transaction was the First Nations Finance Authority. The FNFA, based in British Columbia and operating since 2005, provided the coalition with a $250-million loan for the Clearwater purchase, which it called a “historic step forward for the Indigenous economy.” That Indigenous economy is, by some calculations, a powerhouse-in-waiting, owing to a young, fast-growing population and court rulings and legislation that support Indigenous rights.

Providing a welcoming runway for that work force, in the form of education and opportunities, could benefit both Indigenous communities and government finances.

In a 2016 report, the National Indigenous Economic Development Board estimated closing the productivity gap between Indigenous and non-Indigenous Canadians would lead to an annual increase of $27.7-billion in GDP.

First Nations, Inuit and Métis communities face a daunting infrastructure gap – estimated to be as much as $30-billion – when it comes to services such as drinking water, waste water, roads and broadband connections.

And after this year’s confirmation of unmarked graves at several residential schools, those communities want the next government to implement the calls to action of the 2015 Truth and Reconciliation Commission report. – Wendy Stueck

Digital transformation

The pandemic accelerated Canada’s digital transformation, spurring widespread adoption of e-commerce and remote work. The incoming government needs to build on this momentum while making high-stakes decisions about the infrastructure and regulation of the digital economy.

The central issues are 5G wireless service and rural broadband. Canada’s telecommunications companies are racing to build ultrahigh-speed wireless networks across the country – which are expected to underpin a range of new industries, from autonomous vehicles to telemedicine – and are expanding internet services to remote areas. During this build-out, the federal government needs to balance affordability against the need for massive private-sector investment.

Large telecom companies want to limit competition, especially in 5G spectrum auctions, arguing they need to be able to make a decent return on their multibillion-dollar investments. Smaller companies say increased competition will bring down consumer prices. Crucially, the incoming government will have to decide whether to green-light Rogers Communications Inc.‘s proposed $26-billion acquisition of Shaw Communications Inc. and whether to allow the use of equipment made by Chinese telecom giant Huawei Technologies Co. Ltd. in Canada’s 5G system.

The next government is expected to oversee the introduction of open banking legislation, aimed at giving banking customers more control over their data and encouraging competition from fintech startups. Policy makers must also keep an eye on advances in artificial intelligence, quantum computing and digital currencies, all of which could drive major economic changes in the coming years. – Mark Rendell

Productivity and innovation

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Canada is a perennial laggard when it comes to productivity. The amount of GDP generated each hour worked has been below the OECD average for decades. Economists attribute this to weak business investment in machinery and equipment, low research and development spending and barriers to interprovincial trade, among other things.

The need to boost productivity is growing more acute as the population ages. Fewer workers supporting more retirees means the country will depend increasingly on productivity improvements to drive economic growth.

Innovation is central to the conversation. Canadian companies spend less on R&D than businesses in most developed countries and have a poor track record when it comes commercializing intellectual property. Access to venture capital for startups has improved over the past decade, but companies have difficulty scaling up. Those that do are often bought by U.S. competitors.

Various party platforms suggested reforming the R&D tax credits and improving the patent system. Industrial policy is also back in vogue. Both the Liberals and the Conservatives promised to funnel large amounts of money into industries such as zero-emission vehicles and hydrogen production, and both pledged to create a major new research institution modelled on the U.S. Defence Advanced Research Projects Agency (DARPA). – Mark Rendell

Trade

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Canadian diplomats may have breathed a sigh of relief when Joe Biden replaced the mercurial Donald Trump as U.S. President last year, but Canada’s trade tensions with the United States have not disappeared.

Mr. Biden cancelled the Keystone XL pipeline permit on his first day in office. The State of Michigan is trying to shut down Enbridge Inc.’s Line 5 pipeline, which carries as much as 540,000 barrels of oil a day from Western Canada to Ontario through two U.S. states.

Meanwhile, Canadian diplomats are trying to make sense of the “Buy America” provisions in that country’s US$1-trillion infrastructure spending bill, which could keep Canadian firms from bidding on major government-funded projects.

Geopolitical changes will complicate the trade file. The rising tension between China and the U.S. is leading both countries to rejig global supply chains to their own strategic advantage. Meanwhile, institutions at the heart of the liberal trading order, notably the World Trade Organization, have become dysfunctional, making bilateral and regional trade agreements even more important.

Canada’s own trade relationship with China has grown enormously in recent decades, but the political relationship has soured since the detention of Huawei executive Meng Wanzhou in Canada and Canadians Michael Spavor and Michael Kovrig in China. How the incoming government navigates these uncertainties will have major implications for Canada’s trade-oriented economy. – Mark Rendell

Taxes

The closest Canada has come to comprehensive tax reform occurred half a century ago. Since then, an ever-growing list of exemptions, deductions, tax credits and other set-asides have resulted in a tax system as riddled with complexity as it is susceptible to avoidance.

The 2021 campaign will make a bad situation even worse, with both the Liberals and Conservatives continuing to wield the tax code as a wedge to win votes.

The NDP is the only major party proposing a comprehensive tax review. Presumably, the New Democrats don’t intend to push for what economists say Canada really needs: a broad debate about simplifying taxation to encourage investment and push up long-term productivity.

Such a debate would focus on eliminating tax credits and incentives in favour of lower rates and simplified rules. It would entail shifting the tax burden away from income – particularly corporate income – and toward consumption. And it would focus on allowing the provinces to increase sales taxes as Ottawa trims marginal income tax rates.

Canadians didn’t get that debate during this campaign. But to galvanize economic growth, it’s one that will need to start soon. – Patrick Brethour

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