The Conference Board's economic growth forecast for Canada in 2014 is about 2 per cent for the third consecutive year – an unimpressive number. Slow growth in government spending accounts for some of it, but a key factor is the sustained weak levels of private investment.
The fiscal adjustment under way is necessary at this point in the business cycle. The federal and provincial governments stepped up during the 2008-09 recession, as they should have, and Canadian governments were consequently pushed into deficit. Now that the economy is growing, restoring fiscal balance within a reasonable time frame and keeping public debt levels under control are essential to responsible and symmetrical fiscal policy.
The continued slow pace of growth in private investment – now the lagging edge of the Canadian economy – is more troubling. Private investment grew by 13.5 per cent in 2010 as the economy recovered from the global recession, but the pace of investment growth has slowed over the past three years. The Conference Board projects private investment to grow about 1 per cent in real terms in 2014 before picking up in 2015.
Multiple years of weak private investment growth are not a good sign for the long-term competitive health of the Canadian economy, particularly after governments made considerable efforts to improve the tax environment for businesses operating in Canada.
What's behind this story? From an economy-wide perspective, too many Canadian firms are still in wait-and-see mode, five years into the economic recovery. Cash holdings by Canadian businesses exceeded $625-billion at the end of 2013, the highest in the G7 as a share of the overall economy. Canadian firms apparently remain uncertain about the direction of the Canadian, U.S. and global economies. Therefore, they continue to sit on mounds of cash rather than investing for growth and competitiveness.
A highly accommodative monetary policy since late 2008 has driven down nominal interest rates to all-time lows. The yield on savings has never been lower, just as the cost of funds for business investment has never been lower. These record-low interest rates, along with a much more competitive business tax environment, were supposed to spur private investment. But the payoff remains elusive.
A bottom-up perspective on the competitive conditions in key sectors can provide greater insight. The Conference Board of Canada produces a regular detailed profit forecast for 16 industries ranging from autos to oil, and telecommunications to construction. The analysis considers both demand and supply factors – buyer demand and the growth outlook for each sector, competitive conditions, capacity utilization, and labour and input cost pressures – in order to reach a view on each sector's profitability.
Half of the 16 sectors are expected to grow their production by over 2 per cent annually to 2016, which presumably should encourage investment in those sectors. But the other half are projected to grow slower than the overall economy. Moreover, only four sectors – telecommunications, computer parts, computer services and hotel accommodation – are projected to see profits grow by over 5 per cent annually over the same period.
Rising profits are a key factor supporting private investment, so based on the current outlook there are not a lot of market-specific reasons why most Canadian industrial sectors would step up and start investing faster. Canadian executives would appear to be echoing this message through their comparatively risk-averse reaction to further investment.
What could change this underwhelming investment outlook? Stronger U.S. and global outlooks through 2015 would help shore up business confidence, leading to higher investment. Improved access to global markets through freer trade and investment could be a catalyst for investment, as would greater trade diversification, particularly with high-growth economies – and both would simultaneously increase competition with the Canadian economy.
However, we doubt that more across-the-board cuts to business taxation would be the right policy response. Much has already been done to create a more competitive Canadian business tax environment. At this stage, any business tax policy changes should be highly selective and targeted.
More fundamentally, Canadian businesses will have to embrace innovation if they are to grow and prosper – indeed, if they are to survive over the longer term. According to Statistics Canada, real business investment in research and development averaged almost $12-billion annually in the first half of the 2000s, but has dropped steadily since 2006. Currently, Canadian businesses are investing only about $10-billion a year in R&D. The Conference Board's Centre for Business Innovation is examining how to create and foster a corporate culture of innovation.
For now, the keys to those vaults of corporate cash remain tucked away, for reasons that vary by company and industry. Stronger global and U.S. growth prospects are probably the best way to unlock the cash.
Glen Hodgson is senior vice-president and chief economist at the Conference Board of Canada.