Neglecting the Motherload of Economic Stimulus

Businessman watering potted tree in modern office

Economists do not agree on much. But nobody in the dismal science disputes the fact that economic growth is labour-force growth plus productivity growth. And since productivity is output per unit of input, improving productivity growth is a must if you aspire to improve economic growth, especially in Canada, where labour-force growth is now stuck at about one half of one per cent annually.

Alas, when it comes to productivity, our economy is currently achieving annual growth of about one per cent per year. As a result, future annual growth prospects for our economy sit under two per cent, which is a far cry from the three-plus-per-cent-growth days of much of our history.

It doesn’t have to be this way. All roads to productivity growth go through workers having the best and most innovative facilities and tools. That is business investment. In Canada, consumer spending, at about 60 per cent of gross domestic product (GDP), swamps business investment, at about 12 per cent. But it is business investment that shapes our economy for the longer term.

Simply put, business investment is the motherload of economic stimulus. It is a gift to growth that keeps on giving because it translates into the workplaces, equipment, machinery, intellectual property, and research that Canadians use to produce goods and services. Business investment, for example, is responsible for the classrooms, chairs, desks, white boards, visual equipment, and computer hardware and software that I use to teach MBAs.

Unfortunately, as things stand, it is charitable to call Canada’s business investment a problem. Our record here borders on serious neglect. Economic growth, productivity, standards of living, competitiveness, and innovation are all affected.

A few facts summarize our predicament. The business investment to GDP ratio is the key metric. Here, we are entrenched towards the bottom of the list of countries with whom we compete for economic activity. Between the beginning of 2015 and the end of 2017, Canadian business investment to GDP averaged about two percentage points per year below the United States, more than four points below Japan, Korea, Australia, and Belgium and about one point below France, Germany, and the Netherlands, according to the October 2017 Fraser Research Bulletin. (Anyone who thinks one percentage point does not matter should reflect on the compounding effect over 30 years of 1 per cent weight growth per year: a 140-pound person grows to 189; a 170-pound person to 229. In the long term, year after year compounding always carries the day for good or bad.)

“The issue is not just about the willingness of Canadian executives to invest.”

The issue is not just about the willingness of Canadian executives to invest. Foreign direct investment (FDI) has been seriously struggling for years as foreign investors in our economy have been voting with their financial feet. While FDI has been showing positive signs, there remains much to make up.

Simply put, our lamentable business investment situation has multiple causes:

  • First, soft and uncertain economic conditions are a big damper on willingness to commit capital. With the economy struggling since the 2008 financial crisis, executive have been holding off on investments, waiting for things to visibly improve rather than risk being stuck with unneeded production capacity.
  • Second, household credit is now in the vicinity of a record 175 per cent of disposable income. Add to that very low Canadian savings and small wonder that executives are anxious about the willingness and ability of Canadian consumers to buy the additional goods and services that would result from more production capacity.
  • Third, Canadian business investment is biased towards resource sectors, particularly oil and gas, and there the economics have not been conducive to business investment. World energy prices have been soft and unstable and then there are our well-known problems building pipelines that would move oil to ocean terminals for export to world markets.
  • Fourth, when the Trump administration in Washington cut the U.S. corporate tax rate from 35 per cent to 21 per cent, it put an end to a significant Canadian economic advantage. American and Canadian corporate tax rates are now more or less the same. Business investment decisions are driven by hard rate-of-return numbers and no stroke of the pen improves an investment’s rate of return faster than a big drop in the tax rate a business pays. Our trade/tariff troubles with the United States get most of the headlines, but arguably the U.S. corporate tax rate cut is the more damaging. Our approach to taxing carbon relative to the United States only adds to our business investment tax-competitiveness problem.
  • Fifth, Donald Trump again. No business is immune to government regulation. The Trump administration has torn up the U.S. rulebook to the delight of U.S. executives long frustrated by a seemingly endless and ever-growing list of regulations, rules, bylaws, codes, standards, inspections, approvals, and licences with which they must comply covering everything from products, promotion, and pricing to health, safety, and the environment. Canada’s rulebook for businesses marches on unabated, making the United States now a much more attractive place relatively speaking to invest.
  • Finally, Canada’s federal deficit is not a plus for business investment. Large and often growing deficits with balanced budgets nowhere on the horizon is a scary movie that executives have seen before. It leads to growing interest payments, which greatly increase the probability of tax increases on businesses and, lest we forget, individuals who have already hit about a 50 per cent marginal tax rate on incomes over $200,000. For executives, OUCH!!!

Canada’s need to stimulate business investment borders on critical. Here is what business got between the 2018 Fall Economic Statement and Spring 2019 Federal Budget, with almost everything substantive coming from the former.

  • About $14 billion in incentives to business investment over the next six years in the form of accelerated capital cost allowances and immediate write-offs.
  • Close to $2 billion over six years to develop new export markets, improve transportation facilities, and stoke innovation.
  • The introduction of an Annual Regulatory Modernization Bill to get rid of outdated regulations and update others and the creation of a Centre for Regulatory Innovation.

Given the scale of our business investment problem, that’s thin gruel. The financial package is far too small relative to our $1.8 trillion economy to move business investment in any meaningful way. Meanwhile, non-financial incentives are more process- than action-oriented, and there is no scorecard against which to monitor and drive progress.

Existing public policy on the business investment front is simply not adequate. Government rhetoric needs to be backed up with monetary and non-financial incentives that will significantly change corporate behaviour. A much bigger tax package would be a good place to start. But politicians of all stripes are missing the urgency. And until that changes, terms like “cutting edge” and “state of the art” won’t be often used to describe our assets. Our workers and society deserve better.

The impact that business investment has on our economy is immense. But like too many other real issues, it isn’t a headline story, which is why executives need to press the business investment agenda with the government at every opportunity. If the business community doesn’t press the issue, who will?

About the Author

John S. McCallum is Professor of Finance at the I. H. Asper School of Business, University of Manitoba, and former Chairman of Manitoba Hydro. Contact John.McCallum@umanitoba.ca.

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