Trudeau government must act now on trade, taxes as possible recession looms

As Parliament resumes, Canada’s policymakers face a turbulent state of affairs as the United States and China wage an economic Cold War armed with tariffs and Ottawa continues negotiating with the Trump administration over NAFTA, with an American deadline looming September 30.

Alongside all this, there’s mounting evidence that Canada’s economy and federal fiscal situation are declining and that we may be on the verge of a recession. Indeed, the economic challenges facing the Trudeau government are intensifying.

For example, the unemployment rate in August rose to six per cent with Ontario leading the way, losing about 80,000 jobs. Rising interest rates, combined with economic uncertainty on the trade front, have eliminated the economic momentum that helped create a stronger employment situation. In 2017, employment grew by nearly two per cent. Based on results to-date, in 2018 growth fell below one per cent, with July and August showing employment declines.

And slowing employment growth is accompanied by Canada’s perennial capital investment lag. As noted in a recent Fraser Institute study, the growth of overall capital investment in Canada slowed substantially from 2005-2017 and was lower than in virtually any period since 1970. More ominously, it appears the shares of total investment in machinery and equipment—the core of investments needed to boost economic productivity—has been declining while the share of total investment accounted for by housing is up. Indeed, the delay of the Trans Mountain pipeline project is a serious blow to boosting productivity in our natural resource and transportation sectors given so much of our transportation network is geared towards the movement of natural resources including oil and gas.

In fact, Canada’s capital investment performance has looked better than it actually is by the hot housing sector. Given that so much of Canada’s recent economic growth has been tied to housing wealth, indebted consumers (i.e. homeowners) will be stressed if employment losses mount and interest rates continue to rise. The slowdown in the housing market in response to government policy initiatives and the gradual rise in interest rates makes the deterioration in the business investment climate even more serious. Uncertainty over NAFTA, and a more tax competitive U.S. business sector, do not bode well for a pickup in Canadian business investment, especially in the absence of any aggressive measures on the corporate tax front.

And if all this is not enough to keep Finance Minister Bill Morneau up at night, a slowing economy means that the federal budget deficit projections in the 2018 budget may be underestimates if government revenues weaken. The 2018 budget forecasts continuous deficits that would see net federal government debt rise from $757.8 billion in 2018-19 to $831.5 billion by 2022-23—an increase of nearly ten per cent.

Moreover, the optimistic forecasts of GDP growth in the budget made for a declining federal debt-to-GDP ratio—but that’s certainly not in the cards if the economy slides into recession. If debts and deficits are higher than projected, it will be yet another blow to business investment confidence in Canada.

The Canadian economic train may be close to going off the rails. To improve the country’s business investment climate, the Trudeau government should have three main priorities. First, resolve the trade situation with the U.S. via a new trade agreement or other significant trade initiatives designed to boost and diversify our trade. Second, rein in the federal deficit now, in advance of any further economic slowdown, which would increase our already large federal deficits and debt. Third, reform corporate taxes to make our business sector more competitive. The time to act is now.