Falling off the ‘fiscal cliff’ will hurt Canada too

It has been said that when the U.S. sneezes Canada catches a cold.  Today, America’s economy has a low grade fever that could develop into pneumonia in the next few months.  This takes the economic form of relatively slow post-recession growth by US historical standards—an annualized rate of 2.0% according to the US Department of Commerce’s most recent estimate.  The looming pneumonia is another American recession, a very real possibility.
The path the illness takes is dependent in the immediate term on whether Washington avoids the so-called “fiscal cliff”.  If the politicians fail to avoid driving off this cliff, the American economy will suffer a major blow and will in all likelihood fall back into recession.  This would be very bad news for Canada’s economy.
At the end of this year, the tax cuts put in place by President Obama’s predecessor, George W. Bush, which has been considered important stimuli during and after the recession, will expire. This will take purchasing power out of the hands of the debt laden American consumer.  At the same time a “sequester,” part of the 2011 Budget Control Act, indiscriminately cuts $1.2 trillion over nine years from spending in Washington.  According to the Congressional Budget Office, the combined effects of these two measures equal about 3.6% of GDP in 2013.  Other analysts say it could be more like 5% of GDP, either of which is enough to end the fragile US recovery and tip the economy back into recession.
To avoid falling off the fiscal cliff the newly elected Congress and the Administration would have to agree before the end of the year on a budget that reduced Washington’s deficit by an amount at least equivalent to the sequester.  In theory this is very easy.  As TD CEO Ed Clark recently said, “If you put five economists in a room and say you each have half an hour to come up with a solution for the United States (fiscal problem), all five could say, ‘I don’t need half an hour.’”  In practice, however, it seems an almost impossible task in the ideologically divided Washington of today, which reflects the deep divides within American society itself on the role and size of government—what The Economist calls “The 50-50 nation”.
What does all this mean for Canada?  We are a trading nation.  One third of our GDP, and one in five jobs in Canada, is export dependent.  While Canadian exports to the US have declined in recent years – from a peak of over 80% of Canada’s total exports a decade ago—the US is still far and away our biggest market, accounting for nearly 74% of Canada’s exports in 2011.  By contrast, Mexico, our other NAFTA partner, accounted for a paltry 1.2% of Canada’s exports last year, the UK 4.2% and China 3.8%.
Hence, if the US tips back into recession as a result of falling off the fiscal cliff, the negative economic effects in Canada will be real and significant, slowing what is already relatively slow growth in this country.
We also know that when the US economy struggles, protectionism south of the border rises.  This came home to Canadians in spades during the 2008-09 recession with the Buy American provisions of the American Recovery and Investment Act of 2009, which excluded Canadian firms from supplying projects funded under Washington’s stimulus measures.  Further protectionist measures emanating from Washington and negatively affecting Canada’s exports could rear their ugly heads if there is a second US recession in five years, in a country with a persistently high, and historically anomalous unemployment rate—nearly a percentage higher than that of Canada.
Put simply then, averting the fiscal cliff in Washington really matters in this country, as Canada’s Ambassador to Washington Gary Doer made clear Wednesday in a speech in Vancouver.  So let’s hope our friends to the south can get beyond their 50-50 divide in the next sixty days and come to agreement on a new fiscal plan that will avoid plunging their economy into another recession and doing significant economic damage to their neighbour.

Can a Small Change Budget Transform Canada’s Economy?

The federal Budget thus far seems to be known most for eliminating the penny, a small change initiative if there ever was one.  Yet the government claims Budget 2012, entitled Jobs, Growth and Long Term Prosperity, will secure Canada’s long-term prosperity, which, according to Mr. Flaherty and the Prime Minister, is anchored in this country’s innovation performance.

This budget, like many others over the past fifteen years, spills a lot of ink on Canada’s well- documented innovation deficit.  There is a whole chapter on “supporting entrepreneurs, innovators and world class research”.  The government claims that its approach to innovation policy, as outlined in the Budget, will, over time, transform Canada’s economy, making it much more innovative and globally competitive. This, in turn, will secure our prosperity.
Does the substance in Budget 2012 line up with that claim?
For at least fifteen years, successive governments – Liberal and Conservative – have tried to improve the Canadian business sector’s woeful innovation performance, primarily through spending and tax measures of various kinds. These are aimed at stimulating private and public sector research and development, and the commercialization of that research. Spending on R&D is effectively considered, in government circles, to be a rough proxy for innovation. As a result, we have seen a litany of tax and spending measures over the years, and the creation of all kinds of new entities to deliver that agenda.  And yet Canada has barely moved the needle at all on innovation and productivity performance.
Budget 2012 devotes a total of $1.1 billion over five years to improving Canada’s innovation performance.  To some, that might sound like a lot of money, especially in the context of an austerity-focused government.  It isn’t: it is trivial.  It amounts to one tenth of one percent of total federal spending.  It is a drop in the ocean in a $1.75 trillion economy.  It is considerably less innovation-related expenditure than most governments – including previous Conservative governments – have apportioned in recent budgets.
So how can the government seriously claim that Budget 2012 is all about the economy’s long-term prosperity, which it acknowledges is bound up with improving Canada’s innovation performance?
Here’s how.
Budget 2012 basically throws in the towel on the traditional federal approach to improving innovation performance through government spending and tax incentives.  The government seems to have concluded that this standard remedy isn’t working after many years of considerable federal effort.  The evidence suggests they are right.
The government also seems to have concluded that the most significant thing they can do to improve Canada’s innovation performance is to expose the Canadian business sector to the full forces of global business competition.  This is the Harper government’s new innovation agenda for Canada.
Budget 2012 is unique, and quite bold, among recent federal budgets in one respect.  It devotes 10 pages to outlining how the government is “expanding trade and opening new markets for Canadian business”.  This globalization agenda has been emerging piecemeal over the past 18 months, and is now laid bare for all to see in the Budget.  The Harper government is embarking upon the most significant international trade agenda in memory – opening up free trade talks with the EU, India, Japan and the Trans Pacific Partnership (a multi-lateral free trade agreement centered in Asia), and beginning exploratory free trade discussions with Thailand and Mercosur (a customs union involving four large south American countries).  In addition, the government recently signed a foreign investment protection agreement with China – which was 18 years in the making – and is now finally taking a serious interest in Chinese trade and investment.
Exposing Canadian business to the full forces of global market competition, and prying open foreign markets for Canadian exports, is also a textbook way to drive innovation performance in the business sector.  And it doesn’t cost a penny pinching (and penny eliminating) government any money at all to do so.
That is why Budget 2012—“the small change budget”—could actually do as the government says, and significantly improve Canada’s innovation performance in a way no previous government has been able to.  The only remaining question is this:  Are Canadian businesses and workers prepared to meet the gale winds of global competition?

A new Asia strategy for Canada

For the past 250 years, Canada’s deep and mutually beneficial economic links with its superpower neighbour to the south have stood as a cornerstone of our growth and prosperity. While the US will continue to be a major economic partner and critical ally for Canada, its hegemonic days are likely over. The size of the Chinese economy alone is expected to rival that of the US by 2020 – 2030.  That gives Canada only a decade or two to accomplish a major re-orientation of its economy.
The economic links between Canada and the US are broad as well as deep.  There is a deep web of ‘connective tissue’ that binds the two countries, not just economically, but also socially, culturally, and politically. Asia, on the other hand, feels geographically and culturally distant. Links are sparse and Canadian businesses lag their rivals in terms of Asian penetration: only half of the 20 largest Canadian companies have operations in Asia – 100% of the top 20 American companies do.
Canada has a significant mountain to climb. Recent McKinsey research found that not only did many Chinese consumers not know where Canada was, but that the only reference they had for the country was that it was the “place to go for clean air”.
The re-orientation of Canada’s economy towards Asia is unlikely to happen organically – and certainly not at the speed required. The kind of strategic thinking, action and coordination required to achieve this will be a challenge in Canada’s decentralized system of governance.  But previous challenges have brought Canada’s government, business and civil society communities together to act jointly to address major issues. We must do it again. For without such strategic action, Canada’s future prosperity and political power and relevance are at risk.
A first step is for the Prime Minister to appoint a Minister for Asia and establish an Asia Advisory Council made up of 15-20 influential Asia-based politicians and business people. The Minister for Asia would be a key contact point for Canadian businesses, civil society and Asian governments.
Second, we should seek to build on our strong base of human ties with Asia. Increasing the number of Asian students studying in Canada has benefits beyond the pure economics; it also extends personal links that will bear fruit into the future. At the same time we should increase Asian content in our own education system.
Governments in Asia are very strategic about supporting their own companies. We should take a leaf out of their book, identifying and actively supporting strategic sectors. There are many good candidates, including infrastructure, agri-food, aerospace and financial services.
Canada has some of the most admired infrastructure in the world and China has a huge infrastructure need: by 2025 more than 220 Chinese cities will have over 1 million inhabitants. Our financial system came through the 2008 crisis in stronger shape than those of other developed economies and our regulatory system and banks are globally recognized for effective governance and risk management. Aerospace presents another opportunity. China and other Asian countries are keen to develop aerospace industries.  Bombardier is the third largest civil aircraft manufacturer in the world and we also have many successful suppliers to the industry.
Growing Asian interest in both consuming and owning Canadian resources is inevitable. This presents opportunities and risks for Canada. Overseas investment could help bring down the cost of development, expand and modernize our resource infrastructure and create more jobs for Canadians. To take full advantage of this opportunity Canada must proactively invest in its resource infrastructure. We cannot build an energy link to Asia, nor become an energy superpower, unless pipelines to the West Coast are built and the necessary export facilities and shipping lanes authorized.
At the same time, it is imperative that Canada has in place an effective long-term plan for managing its own resources. Our current policy on foreign ownership is unclear to many. We must also ensure that we are not simply spending the wealth of future generations. The Government of Canada should consider working with resource rich provinces to establish an investment fund, like Norway’s, to ensure that future generations of Canadians benefit as much as Canadians of today.
The world is re-balancing towards Asia; Canada must re-balance with it. This will not happen without strong federal government leadership. Canada’s own Asia century must start now.
Dominic Barton is global managing director at McKinsey and Company.

Skilled trades deficit colliding with energy boom

For many years we have been told Canada faces an acute “skills mismatch,” where the economy has lots of great jobs for the highly qualified – notably engineers, information technology professionals, and science PhDs – without enough of these people to meet the demand.
But a second skills shortage has crept into the economy that promises to dwarf the professionals deficit. This less-talked-about shortage is being driven by two forces on a collision course: unprecedented demographic change and an equally unprecedented boom in one large, growing and labour-intensive sector of the economy.
This is the skilled trades deficit – an acute shortage of electricians, welders, pipefitters, plumbers and carpenters. Exacerbating the problem is the corresponding economic boom in the energy infrastructure sector, with a projected investment over the next 20 years that is breathtaking.
The collision of these forces of declining labour supply and booming energy construction demand requires governments – federal and provincial – to develop a pan-Canadian strategy to meet the challenge and seize the economic opportunity.
Growth in the labour force is slowing as baby boomers retire. Forty years ago, the labour force grew at about 4 per cent a year, on average. A decade from now, growth will fall to almost zero.
This trend is particularly acute in the skilled trades. Between 2011-19, according to the Construction Sector Council, 208,000 skilled tradespeople will retire – with only 111,000 new recruits entering the trades. If you think you have trouble finding an electrician today, wait five years.
This trend is running headlong into two distinct forces on the demand side of the ledger. First is the boom in the oil sands, which depends intensely on skilled trades. Second, and less well known, is a requirement over the next 20 years to refurbish Canada’s aging system for electricity generation and distribution, which has been allowed to atrophy over the past two decades.
The Canadian Energy Research Institute estimates that about 800,000 incremental jobs, many of which are skilled trades, will need to be filled in the oil sands alone over the next 20 years; and that capital investment in the oil sands will exceed $250-billion over that time frame.
Add to this the Conference Board’s estimate that the electricity sector will invest nearly $300-billion over the same period to maintain existing assets and meet market growth, and you have the largest construction boom since the postwar period.
As a result of these two competing forces – unprecedented labour force contraction running up against equally unprecedented demand for skilled trades – the next seven years alone will see the economy coming up short by about 156,000 skilled tradespeople.
On one hand, this is a good-news story. Long-term career prospects in the skilled trades look very promising. But we have nowhere near the number of people in the pipeline today to meet this demand, nor do we have the public policy framework to significantly increase the skilled-labour pool. And as each year passes, we have fewer skilled people to pass along the expertise, making the replacement work force challenge that much greater.
Immigration is an important short-term fix, but it alone cannot solve the longer-term problem. Nor should immigration of skilled tradespeople be seen as the long-term solution for a country with an unemployment rate of nearly 8 per cent, and much higher for some population segments, notably native people and other underrepresented groups.
This historic construction boom represents a unique, once-in-several-generations, opportunity that Canadians should seize upon. Labour market policy is an area of shared jurisdiction. Ottawa has some levers, such as immigration and financing for training; the provinces have others, such as education policy, training programs and credential recognition; and internal labour mobility is shared between the two levels of government.
All these levers need to be pulled in a co-ordinated fashion to ensure that the Canadian economy and Canadian workers reap the full benefit. Canada needs a national work force strategy.