Clemens & Palacios: Positive economic news masks underlying weaknesses

Today, the Trudeau government will table its first budget in more than two years.

According to a recent report from Statistics Canada, the economy expanded by 2.3 percent in the fourth quarter of 2020 (inflation-adjusted). And StatsCan’s latest Labour Force Survey showed employment increasing by 259,000 jobs in February and the unemployment rate declining to 8.2 percent, the lowest level since March 2020.

While Canadians should welcome positive economic news, particularly as we recover from the COVID-19 pandemic, these latest numbers should not mask the underlying weaknesses of the Canadian economy and government finances that predate the pandemic and recession, otherwise we risk giving license to government to spend and borrow yet more money, which will actually impede — not facilitate — recovery.

Indeed, this latest economic news is largely due to the natural recovery of the economy from the deep pronounced recession. The economy contracted by 5.4 percent (inflation-adjusted) in 2020, the largest decline on record. Unemployment hit 13.0 percent in April of 2020 with 5.5 million Canadians suffering from unemployment or reduced hours.

We should expect continued strong economic news for much of 2021 as COVID becomes more manageable through vaccines, the economy opens up and natural recovery continues. However, after a bounce from the bottom, it’s likely Canada will return to meagre growth over the medium term.

Consider data from a recent study comparing economic performance for four-year-periods preceding recent recessions. Between 2016 and 2019, per-person GDP (inflation-adjusted) grew at an average annual rate of just 0.8 percent compared to 1.5 percent between 2011 and 2014 (before the 2015 recession) and 3.7 percent between 1997 and 2000 (before the 2001 economic slowdown).

Average annual growth in private-sector employment was also weak (1.5 percent) between 2016 and 2019 compared to 2.9 percent between 1997 and 2000 and 3.3 percent between 1986 and 1989.

Economic performance was weakest with respect to business investment, which most economists agree must be a foundation for recovery. Using the broadest measure of business investment, which includes residential housing, Canada suffered from an average decline (inflation-adjusted) in business investment between 2016 and 2019 of -0.2 percent.

The average falls further to -0.9 percent if residential housing is excluded, compared to average growth at or above 6.8 percent in each of the four-year periods preceding the last four recessions — 6.8 percent for 2011-14, 7.0 percent for 2005-08, 9.2 percent for 1997-00 and 8.0 percent for 1986-89.

Federal finances were also not in great shape pre-COVID. The Trudeau government increased per-person federal spending (inflation-adjusted, excluding interest costs) to $9,500 in 2020-21, the highest level in Canadian history. Additional COVID-related spending caused per-person spending to hit at least $17,090, more than 90 percent higher than spending during the 2008-09 recession and almost 120 percent higher than spending during the Second World War.

Importantly, the increase in federal spending (again, pre-COVID) from $273.6 billion in 2015-16 to $349.1 billion in 2019-20 was financed almost entirely by borrowing. The national debt (after adjusting for financial assets) increased from $708.6 billion in 2015-16 to $812.9 billion in 2019-20. The recent fiscal update (fall 2020) indicated that borrowing in 2020-21 will reach $381.6 billion plus an additional $271.0 billion between next year and 2025-26, which will see the national debt (adjusted for financial assets) reach $1.5 trillion.

It’s within this environment — weak economic performance and deteriorating government finances — that the federal government and other advocates for expanded government suggest massive increases in federal spending on pharmacare, daycare, infrastructure and new green spending aimed at redesigning the entire economy. Such spending necessarily entails much higher taxes and/or borrowing, which will both negatively affect the country’s recovery.

On the day of the federal budget, it’s important to remember that none of these policies — new higher government spending, higher taxes and higher government debt — helped produce a stronger economy pre-COVID and will not encourage what the Canadian economy needs more of, namely entrepreneurship and business investment.