Carney finally goes big

In a recent speech that received hardly any attention, Bank of Canada deputy governor Nicolas Vincent provided valuable framing for how to think about the country’s productivity crisis. (Part of some great work the central bank has been doing on the issue.) Vincent suggested that Canada may now be caught in a “vicious circle,” where weak productivity, weak expectations, and weak capital spending are reinforcing one another. It’s what others might call a low-investment trap, an unwelcome state where companies expect too little from the economy and then hold back investment in ways that make those expectations come true. The latest GDP numbers out last Friday, which showed the share of business investment in the economy has dropped to the lowest in more than two decades, highlight the urgency of it all. In his speech, Vincent sketched some broad-stroke remedies: improving the regulatory framework; upgrading infrastructure; doing more to scale up companies; increasing competition in key sectors; and investing in talent. All suggestions we’ve heard before. But the vicious-circle framing raises another, perhaps more significant, question. If we are stuck in a vicious productivity cycle or low-investment trap, are incremental policy changes enough to break free? Will companies respond to minor changes in the investment landscape, such as the two-percentage-point reduction in the marginal effective tax rate on investment proposed in the budget? Or do we need a much larger impulse to escape it? Something big enough to shift expectations. A policy shock of sufficient scale that investors immediately believe the landscape has fundamentally changed and that it is now safe and worthwhile to invest again. Last Thursday’s announcement feels closer to that, and Carney deserves credit for it. Of course, the real work of building the economic scaffolding and executing lies ahead. Right now, the MOU with Alberta is only a bookend to the first phase of Carney’s economic agenda. Let’s call it the announcement phase. And the big political risks lie ahead for this government, not behind, with the most dangerous fault lines extending well beyond the pipeline debate. In fact, affordability may be where the biggest political challenges lie. There is an unspoken truth about any agenda, like Carney’s, that puts investment first. If we want to increase the share of GDP that goes to capital spending and infrastructure, the share of the economy devoted to consumption will need to shrink, at least in the short term. Simplistically put, as we invest more, we will probably need to consume less. That shrinking share of consumption could come about in various ways. Investment spending could fuel inflationary pressures and drive interest rates higher, making life more costly for Canadians. Or the scale of investment needed may eventually require higher taxes to finance. Regardless of how it all plays out, the implication is that the path to a truly transformational investment profile is unlikely to be paved with easy political wins on the retail side of politics. Productivity will help make things cheaper in the long run. But it’s possible things could get more expensive in the shorter term. The political risks associated with the Alberta deal may pale in comparison to what comes next. And the government will need all the political courage it can muster.