Private sector investment has become the lagging edge of the Canadian outlook – rather than being on the cutting edge. Years of feeble business investment growth, combined with the current investment pullback in the oil patch, are bringing private investment growth to a standstill.
Indeed, it may be even worse than that. The Conference Board of Canada expects that private investment actually contracted in 2014, due to the depreciating currency. A lower dollar raised the cost of importing new machinery and equipment, thus crowding out any nominal growth in investment spending by businesses. Moreover, Canadian firms continue to sit on a mountain of cash that had climbed to more than $480-billion in the third quarter of 2014, even though interest rates and investment earnings are exceptionally low.
The Conference Board is now projecting net negative private investment again in 2015, which means a further reduction in the Canadian economy's stock of productive private capital. The previous forecast rounds contained signs of an investment growth recovery. The updated investment forecast has been revised downward due to the collapse in oil prices and the negative knock-on effect on investment in new oil production and the related supply chain.
These trends are troubling. Without robust private investment growth, business innovation and stronger productivity performance are unlikely. Absent an investment rebound, firms may need to lean on the crutch of a chronically weak loonie to remain competitive.
What can be done to change this trajectory ? The strengthening U.S. recovery and weaker loonie are working together to build stronger demand for Canadian exports. For firms outside the energy sector, these forces are creating the right incentives to dig into the mounds of cash or access capital markets and invest in their productive capacity. This catch-up in capital stock will take time, however, and we are not expecting to see much of a bump in investment or in export volume growth this year.
As for the energy sector, the sharp reversal in investment intentions is a painful but unavoidable first step in market adjustment. Global oil supply will need to slow to get better aligned with oil demand growth. Only then will prices rebound adequately for the oil patch to be able to respond with renewed investment vigour.
Canadian governments have already moved a considerable distance to try and create more positive conditions for private investment. Capital taxes were eliminated federally and in some provinces, notably Ontario. As sought by business advocates, corporate income tax rates were cut and capital depreciation allowances were adjusted. Some have suggested these business tax adjustments have failed to deliver the desired results – but it is also possible that business investment would have been even weaker without the tax adjustments. There is no counterfactual world for comparison.
Could governments do anything more? Many Canadian governments have already made increased infrastructure investment a policy priority. A modern public infrastructure foundation is necessary for dynamic growth and to address Canada's yawning infrastructure deficit, particularly in our cities. Now is the time to get on with it, using innovative approaches to manage and finance public infrastructure investment with the active engagement of the private sector.
As for further business tax policy reform, our research suggests that "less is more." Rather than adding to the wide array of selective boutique tax preferences for businesses, governments could choose to clean up and simplify the tax code, thereby reducing business compliance costs.
The weakness in private investment, however, can only be fixed by business leadership in the boardroom. Taking risk in order to earn reward is a key principle of our competitive business environment. The opportunity is there for Canadian firms to raise their game, draw upon their cash reserves and boost investment spending in order to seize the export and investment opportunities that await in growth markets, led by the United States. And if not now, when?
Glen Hodgson is senior vice-president and chief economist at the Conference Board of Canada.