IMF report spotlights Canada’s economic woes

The latest report on Canada produced by staff of the International Monetary Fund (IMF) provides a useful summary of recent economic and financial market developments. It also spotlights the structural challenges weighing on the country’s overall prosperity.

The IMF sees the Canadian economy expanding by around 1.5 per cent (inflation-adjusted GDP) per year over 2023-24, as higher interest rates, record levels of household debt, and subdued global economic growth take a toll on consumer spending, business profits and exports. The unemployment rate is expected to climb modestly as the pace of job creation downshifts.

There’s good news on the inflation front. The all-items Consumer Price Index is projected to average 3.6 per cent this year, down from almost 7 per cent in 2022, before falling further to 2.5 per cent by 2024. The Bank of Canada’s inflation-fighting strategy seems to be working, notwithstanding the lack of support from governments wedded to soaring expenditures. The IMF concludes that the 2023 federal budget “implies a weaker fiscal outlook” for the next two years—a polite way of saying that fiscal policy is making it harder to return inflation to the Bank of Canada’s 2 per cent target.

Looking a bit further ahead, the IMF urges Ottawa to adopt a “quantitative fiscal framework” that includes an explicit debt anchor and embodies a stronger commitment to spending discipline than the Trudeau government has exhibited to-date. And it argues that a legislated debt anchor “would reduce the output costs” of Canada’s necessary fiscal consolidation.

Among the other important topics covered in the report are productivity growth and the investment climate.

On the former, the IMF writes that “Canada’s productivity growth has been muted during recent decades and weakened notably relative to the United States.” Canada has also underperformed several other advanced countries in boosting labour productivity since the 1980s. The IMF notes that Canada has long relied on “factor accumulation” to drive economic growth. Since 2015, this has mainly taken the form of rapidly increasing immigration levels.

Expanding the population and workforce does increase the size of the economy, but the IMF observes that it’s “not a recipe for growing per capita income or living standards.” And the data show that this is where Canada has been failing short; prosperity on a per-person basis has been stagnant since the mid-2010s.

Although the IMF report doesn’t mention it, the evidence also indicates a positive relationship between productivity levels and the compensation paid to employees. It follows that failing to turn around Canada’s chronically poor productivity performance will have dire implications for future gains in real incomes and living standards.

As for Canada’s investment climate, the IMF suggests it has deteriorated relative to comparator jurisdictions. As evidence, the report cites the fact that gross fixed capital formation (a broad measure of investment) puts Canada in the bottom quartile among the 38 countries that are members of the OECD. Capital formation is also running “far below the level in the U.S.” Work by other researchers confirms that Canada is lagging badly on key indicators of private-sector non-residential investment.

To explain sluggish Canadian investment, the IMF highlights insufficient product market competition, restrictions on foreign direct investment, and government-fostered policy uncertainty that’s hindering new investment in the mining and energy sectors in particular. These factors are certainly relevant when assessing Canada’s investment climate. But the IMF report is oddly silent on the role of tax policy in shaping investment flows.

Since 2017, Canada has lost almost all the business tax advantages it previously enjoyed vis-à-vis the United States, a development that undeniably has made the country a less attractive place to deploy capital than it was a decade ago. Moreover, Canada imposes relatively heavy personal income tax burdens on top managers, professionals and other high-skill employees whose locational preferences can also affect where large and mid-sized companies choose to invest and grow. It’s hard to imagine that Canada’s dismal investment track record can be fixed without a renewed policy focus on improving tax competitiveness.