Proceedings of the Standing Senate Committee on
Banking, Trade and Commerce
Issue No. 2 - Evidence - February 17, 2016
OTTAWA, Wednesday, February 17, 2016
The Standing Senate Committee on Banking, Trade and Commerce met this day at 4:16 p.m. to study the present state of the domestic and international financial system (topic: the causes and effects of the recent decline in the Canadian Dollar exchange rate).
Senator David Tkachuk (Chair) in the chair.
[English]
The Chair: My name is Senator Tkachuk, and I want to welcome all members of committee and our panellists here.
Before we start, Senator Beth Marshall is taking Senator Black's place, and we have Senator Enverga, who is replacing Senator Gerstein as a permanent member of our committee. He brings with him a wealth of experience in banking, which is kind of rare on this committee, actually. He spent 30 years working for the Bank of Montreal and holds a master's degree from the Schulich School of Business at York University. He's been very active in the Philippine community in Canada and municipal politics in Toronto, and is a welcome addition to our committee. Welcome, Senator Enverga. I promised you that you'd have a good time here. You can let me know how we did at the end of the year.
I would like to welcome the panellists here. I'm going to start from my left and go to my right: From the Conference Board of Canada, Mr. Glen Hodgson, Senior Vice-President and Chief Economist; from the Canadian Centre for Policy Alternatives, Armine Yalnizyan, Senior Economist; and, from the Fraser Institute, Mr. Herbert Grubel, who has been here before. So welcome again, Mr. Grubel. From the C.D. Howe Institute, by video conference, is Daniel Schwanen, Vice President, Research.
With that, gentlemen and ladies, why don't I start in the same order?
Glen Hodgson, Senior Vice-President and Chief Economist, Conference Board of Canada: Thank you, Mr. Chair, and honourable senators. I had a feeling you might do that because my name was first. I usually don't speak from notes, but I made some notes for this because I thought it was a topic that merited a bit of serious consideration.
The Conference Board is an independent think tank, not for profit, evidence based, so you know who we are. I've been chief economist for 12 years. My career was at Finance Canada, the IMF in Washington and EDC, so I've thought about exchange rates a lot in my career. I'm going to give you a bit of a purist's view, focusing more on the policy than the consequences, but I'd be quite happy to take questions about the impacts of a floating exchange rate policy.
Why does Canada have a flexible exchange rate? We were actually one of the first countries to leave the Bretton Woods system of fixed exchange rates in the early 1960s. Most of us don't remember this, but we actually floated in the early 1960s and then re-anchored to the U.S. dollar. We then left the fixed exchange rate world with the Americans in the early 1970s. I'm a big believer in a flexible exchange rate. I think that any departure would be a mistake for Canada.
The floating exchange rate acts as a shock absorber to external events, things that we can't control beyond our borders. It really helps to cushion the impact for business and business revenues through the business cycle or when we have an event, as we saw 15 months ago, when the commodity super cycle basically came to an end and commodity prices began to just adjust downward. It cushions the impact on business revenue. Of course there's a negative impact for many in our economy. Consumers pay more for imported goods. Business also pays more for technology.
We import a lot of our productive capacity from the rest of the world and, arguably, Canadian business missed their window of opportunity. We had a chance, until 15 months ago, to import stuff from the U.S., from Japan, from Europe at a much better price. The window, we think, is now closed. We don't see us returning to the high commodity prices any time soon, but the exchange rate did act as a cushion.
It also creates a substitution bias, if I can sound like an economist for a second. It actually creates a price advantage to buying Canadian. We don't necessarily have to buy the $8 cauliflower. You can buy root vegetables. You can buy carrots. You can buy other things. As consumers have shopped, let's say the last few months, they have been confronted with that choice of how to spend a fixed family food basket, what they will buy. The floating exchange rate does create a bias in favour of buying within Canada when the dollar floats down.
The flexible exchange rate also allows us to shield domestic prices a great deal. I'll talk about fixed exchange rates in a minute. By raising and lowering external prices, we shield the impact on wages and prices within Canada to a great degree.
Apologies for that. I had my phone on because I was being cheeky. I was going to take a photo of the committee. I actually did that in the house yesterday at the House of Commons Finance Committee. I was a witness there too, and I told the chairman that I was tweeting. He was all in favour of it, Mr. Chair, so hopefully you are as well.
A floating exchange rate, a flexible rate, allows you to have open capital markets. It means that we don't have to have capital controls to control the flow of capital in and out of our economy — minimum government intervention in capital markets — and it allows the balance of payments, to a great degree, to self- regulate.
I'm not a purist in a lot of policy. The Conference Board is quite open to thoughtful intervention in government policy. But, on exchange rates, I tend to take a fairly strong purist view because I think you have a choice between that and a fixed exchange rate. There are specific impacts that I want to point to. More and more economies are built around what are called global value chains, and we are integrated into the world economy. The exchange rate has a different impact on different sectors. We did a lot of research when I was at EDC. I actually worked with Stephen Poloz when he was chief economist there more than a decade ago now. We did a lot of analysis on taking apart Canadian trade and looking at the value chain impacts in terms of Canadian content, and the exchange rate will impact different sectors quite differently. It is kind of a broad generalization.
The resource sector and services are actually high Canadian-content sectors. When the dollar falls in value, as it has in the last year, they're the big beneficiaries. The resource sector in Canada would typically have 80 to 85 per cent Canadian content. So they import technology, let's say from the U.S. or Europe, but most of their value is created in Canada. They're beneficiaries because they are hit a little bit on their import prices, but they really get a good revenue impact, shielding them from the adjustment in commodity prices.
Service sectors are high Canadian content. We have done a lot of research recently on service trade. In fact, there's been a real takeoff in the last decade in trade and services. Economists used to think we didn't trade services. Now, in an integrated world, services are actually a really important source of international trade, international investment, and that's where the weakening of the loonie has been very beneficial for service exporters. Manufacturers not so much.
In fact, many manufacturing sectors have only 50 per cent Canadian content. So there are some manufacturers that are actually perfectly hedged, where their import costs are kind of similar to their export revenues, and they can kind of ride the balance. But, in a sector like autos, final assembly of autos, a typical car bolted together in Canada only has about a third Canadian content. So it is a myth that the manufacturers will automatically benefit from a cheaper loonie. They may be paying more for their imports than they're getting as benefit in terms of their sales abroad. You really have to drill deep by sector.
I will point to a piece of research we just published last week — it's on our website — looking at a sectoral breakdown of which sector is the most ready to take advantage of a stronger U.S. recovery and of the dollar re- anchored at 70 cents. We found that there were only five sectors that had the plant in place and the competitive advantages to really take advantage of a weaker dollar. They're going to have to invest before they become competitive going forward.
Our forecasts, looking forward, we see a pickup in Canadian exports in 2017, but not a lot this year. Firms will have to invest to take advantage of the repositioning, a stronger U.S. recovery and the dollar trading somewhere in the low 70-cent range.
I thought I would walk through what economists would call a thought experiment. So what is the alternative? If you don't like floating exchange rates, what would a fixed-exchange-rate world look like for Canada if we went back to the Bretton Woods system, where all of the exchange rates in the world were basically locked in between 1944 and the early 1970s? There are options in between, by the way. There are things called "dirty floats,'' partial intervention. Chinese regulators, for example, have always intervened in their currency market to stop, first, the appreciation and, now, the depreciation of the renminbi. There are some small countries that have auctions.
I used to represent Jamaica at the IMF, and they would have a weekly auction where they would actually set the exchange rate based upon how many U.S. dollars were available. That actually set the price of the market.
Under a fixed exchange rate system, we avoid competitive devaluation, which is why it was created in the first place, but I think it comes at a very high cost. For example, with an oil price or a commodity price shock, as just happened, and the exchange rate was locked in, you would have to take all of the adjustment inside your domestic economy. That means wages would have to fall. That means governments may actually have to run surpluses to take demand out of the market to ensure you don't have a balance of payments problem.
I think the cure is actually worse than the disease. Fundamentally, and having looked at many, many countries around the world, I'm a strong devotee to a floating exchange rate. I know it has costs but I think, for our economy, through the whole business cycle it has advantages. Therefore, if I have a vote today, I vote in favour of maintaining the same policy. For me, "if it ain't broke, don't fix it.''
Armine Yalnizyan, Senior Economist, Canadian Centre for Policy Alternatives: Thank you very much for the opportunity to speak before your committee today to address a topic that is dramatically shaping and reshaping our public policy options and prospects for private-sector outcomes. My notes are available to you in English and French, should you wish them. I will address the questions posed to us as witnesses, in the order they were posed, about the —
The Chair: Excuse me. Senator Day, what are you doing there? Can't you find a place at the table?
Senator Day: I want to be nice and close to the witnesses so that I can hear them. I didn't mean to interrupt.
The Chair: You didn't interrupt. There's a chair right there. In the Senate we're a little different from the House of Commons. Any senator can come to a committee meeting and have a right to ask questions — not the right to vote necessarily but the right to ask questions. Welcome, Senator Day. I hope you enjoy the session.
Senator Day: Thank you, Mr. Chair.
The Chair: Go ahead. Sorry about that.
Ms. Yalnizyan: Thank you so much.
So to the questions we were asked about the causes and the effects of the low dollar. I'll start with: Why is the loonie so low? I will answer shortly to say "a perfect storm of reasons.''
First of all, declining global demand, which has been driven by the slowest growth in 25 years in China, is propelling a downward spiral in demand as companies everywhere are responding to slow sales by cutting their costs. Of course, what is perfectly rational for one company becomes a disaster if everybody does this. The second reason is that oil and commodity supply gluts continue to rise. It's not that the demand for these products is not growing. It is. It's that the supply of these products is growing at a much faster rate, depressing these commodity prices.
The third reason is not that we are just a petro dollar but that we are being compared. The exchange rate we're talking about is with respect to the U.S. dollar, and the U.S. economy is far stronger than ours right now. Their unemployment rate has reached below 5 per cent. That's full employment. The Federal Reserve raised its interest rate for the first time in pretty much a decade in December, and it is a target, a magnet, for foreign investment seeking safe refuge. It's a much more attractive climate to invest in than the Canadian climate at the moment.
All of these things reduce our dollar relative to the U.S.
Now, what are the economic positives of a low Canadian dollar? That was one of the questions you asked us. First of all, we will have more exports. Things produced in Canadian dollars and sold in American dollars, such as oil and beef, wood products, auto products and services, will enjoy higher margins and profits, and we will see more U.S. consumers because of this. The loonie currently offers American purchasers a 40 per cent boost to their purchasing power, so expect to see more American tourists in our vacation spots, coming to our sports events. Expect a really big party at Pride this year if the dollar stays low, and it will be hard to get tickets for the Toronto International Film Festival.
The low dollar reverses the direction of cross-border shopping, which Statistics Canada estimated could be as high as $10 billion in 2012. It will reverse some of that flow. Fascinatingly, we will see some repatriation of capital that migrated south with our snowbirds because Canadians purchased $92 billion worth of U.S. real estate from 2009 to 2015. Now that they're getting 40 per cent more for what they purchased, some of that money will be coming back.
There's also greater investment potential. A lower dollar means lower relative wages, relative to the Americans. Some American businesses will consider doing more production in Canada: for example, "Hollywood North.'' "Hollywood North'' always explodes when the dollar goes south, so to speak. The film industry in Toronto alone was worth over $1 billion in 2014. We've also already seen a quite rapid pickup in advanced manufacturing investments in high tech, in IT particularly in Ontario. That's because we have three innovation hubs: one in Waterloo, one in Toronto and one in Ontario, all of which give cutting-edge opportunities to companies that wish to invest in leading R&D. Of course, when our dollar gets cheaper, our real estate goes on sale for foreign buyers.
Finally, if the dollar stays low, automotive manufacturing reinvestments may be worth a second look by the big three, who are ending the deal they made when they were bailed out. That money comes due in 2017. They will have to decide where they're going to invest in 2017. If the dollar stays low, when it comes to productivity, we have very competitive plants.
The final point about greater investment potential, which Glen touched on briefly, is that Canadians import a third of our GDP. Largely that comes from the U.S. China is a very distant second place at 7 per cent of our merchandise imports. A low-for-long loonie could actually trigger import substitution, which simply means investments could result in Canadians producing more of what we consume because it's too expensive for us to buy it. Again, there's a 30 per cent to 40 per cent premium on everything we buy if it's made in the States, and a 30 per cent to 40 per cent cut if we make it at home.
What are the economic negatives of a low Canadian dollar? First is lower purchasing power. As Glen mentioned, and I imagine we will all talk about it in some way or another, consumers are paying more for imports. Particularly hardest hit are low-income households that are dealing with the higher prices of fruit and vegetables, which are mostly imported from the United States. Businesses that import intermediate goods to put what they're making on the market are also hard hit. The lower loonie acts as both a pay cut and a profit cut for Canadians.
The second economic negative of a low Canadian dollar is retail closures. We're seeing a rapidly changing landscape in retail, which is an important sector for jobs in Canada. Slowing demand has changed the landscape with the closure of giants like Target, Future Shop and many other smaller players. We can expect more corporate consolidation as retailers struggle to absorb the costs instead of passing them through in order to minimize falling sales.
A third is stranded assets. Capital spending in oil and gas fell over 30 per cent in 2015 compared to 2014. Moody's forecast is that it will fall at least another 19 per cent in 2016 and 25 per cent globally. Should demand for these products continue to fall, up to $2 trillion in scheduled projects in Canada are at risk of becoming stranded. We are also looking at the potential for a wave of mining company defaults.
The fourth negative effect of a low Canadian dollar is larger deficits. You may think that those are being driven mostly by low oil prices, but the two are inextricably connected both regionally and nationally, and government budgets are being pressured because of what's happening.
Will the loonie stay low for long? There are a lot of countervailing factors at play. First, there is even more supply growth on the horizon. Iran, which used to be the second biggest oil producing nation in the OPEC until the sanctions in 2012, is about to start pumping again. They're projecting a million barrels more a day as soon as they get going. Globally, producers are already pumping 1.5 million to 2 million barrels more a day than is being consumed. At over 9 million barrels a day, U.S. production essentially didn't budge in the face of these lower prices. The near-record highs in production are over 1 million barrels more per day than two years ago. We have a lot of supply out there and a lot more pressure to drive prices down, which will push the dollar down.
There are also climate change initiatives. We have a hard cap on Alberta emissions and a global commitment to limit global warming not to 2 degrees but to 1.5 degrees at the Paris talks. That constitutes more aggressive policies not only to conserve energy but also to shift towards more renewable sources of generating energy on the way. The EU is ahead of us on this. Their environmental initiatives have resulted in a dropped demand for oil products by 1.5 per cent per year, which is a plausible result in Canada should we move in this direction.
The global economy has been walking on a tightrope in the last few weeks. We have rising concerns about a credit crisis and an asset bubble in China. Globally, we have a corporate bond issue of $29 trillion. There are estimates that a third of the companies functioning on debts are not generating high enough returns on investments to even service those debts.
As well, the increased tensions in the Middle East now involve large economies, such as Turkey and Russia, playing chicken with one another. It's a very dangerous brinkmanship. Any of those three items I mentioned could trigger a global recession, and that could signal a potentially higher loonie.
Finally, there is U.S. monetary policy that might be on the brink of backtracking. We saw weaker than expected growth for January, which caused the Federal Reserve to signal it may delay its plans to raise interest rates on its projected schedule in 2016. If recent slowdowns in manufacturing activity continue, there is even a possibility that the December rate increase might be reversed. The ratification of the Trans Pacific Partnership trade deal could further slow American manufacturing and job growth over the longer term, which could mean a higher loonie.
What can we do? What should we do?
Monetary policy, we know, has very limited impact as we near zero, which is where we're at. Monetary policy has limited impact on the value of the Canadian dollar in relation to the U.S. dollar. If we matched interest rates, we would limit capital flight, but that would have deeper consequences for our economy, which is much weaker than that of the United States. Unlike the U.S., Canada's economy has served up serial disappointments since 2012. Forecasts have been continually downgraded, and current private-sector estimates from the big six banks for 2016 range between a low of 0.9 per cent from National Bank to 1.5 per cent from TD. Essentially, the economy is stalling in 2016.
There is a role for expansionary fiscal policy, but it's limited as to how much it will impact the dollar. Running $20 billion deficits or more, as urged by Bay Street these days, will do little to boost economic growth of a $2-trillion economy. You would have to have a huge stimulus to increase growth. It's that signal that could change the value of the dollar.
I will close by saying that what public policy can and should do with respect to the dollar is look past this year's economic growth and deficit and develop a long-term strategy for building future potential. We are going to need to adapt as a country, and it's not just Canada. We're going to have to adapt to a slow growth as far as the eye can see and, with it, a low-for-long loonie. Welcome to the new abnormal. I look forward to working with you to meet its challenges and unlock its opportunities.
The Chair: I feel better already.
From the Fraser Institute, Mr. Herbert Grubel, Senior Fellow.
Herbert Grubel, Senior Fellow, Fraser Institute, as an individual: Unfortunately, it is necessary for me to say that I am speaking for myself. The Fraser Institute has no opinion.
The Chair: No opinion on the currency?
Mr. Grubel: On any subject. It's very important for fiscal reasons, tax reasons, that we are neutral.
Glen raised an issue on which I have done a lot of work. I don't know whether you are familiar with the concept of the "amero'', the proposal to have a common currency in North America. It was my idea. It was in a book published by the Fraser Institute in which I proposed what the benefits of it all are.
Just to throw out the idea for possible future discussion around this table, let me ask Glen a question. If there are these wonderful benefits of having flexible exchange rates — Robert Mundell got the Nobel Prize for this question — if it's so good, why don't we have a separate currency for Alberta? And if Alberta, well, how do we know whether it's not better to have a separate currency for Edmonton, or for any of the suburbs? If flexible exchange rates are so good what is the optimal area over which we should have a common currency, as we do in Canada? Maybe the Atlantic Provinces should have their own currency. They would have been isolated from a lot of shocks in the past. I'm not in a position to provide answers to this, but just want to challenge your thoughts related to advocacy for flexible exchange rates.
My own contribution is to suggest that we have experienced what is known as a deterioration in terms of trade. What that really means is that Canada used to get 2 cars for 100 barrels of oil; now we get only 2 cars, if we are importing, or the equivalent of bananas or cauliflower. In essence, the deterioration of the terms of trade due to the fall in commodity prices — in particular of oil — means we are poorer, and we have to accept this. I think it is important to remember this when we are talking about policies to remedy it.
We can't change these terms of trade. It's totally beyond us. So we have to live with it. This raises the next question: How long will it last? I'm glad to hear that some people are sticking out their necks and saying, "in 2017,'' and all that. I have never in my entire life made forecasts, especially about the future. All I can say is I don't know, but I also know that the individuals who are reacting to different prices in the future are better placed, looking after their own interests and businesses, to deal with these kinds of problems. One the most serious problems we can cause for ourselves is to think that some civil servant — somebody at the Bank of Canada — has the answer for the future.
I love to tell the story about being on the chairlift with Václav Klaus when he was Prime Minister of what, at the time, was known as the Czechoslovakia. He said, "Herb, you know, I'm being haunted by the media with the question of 'what are you going to do with all of the workers who become unemployed as you privatize all of these previously government-owned industries?'" And he said to them, "If I knew, communism would have worked.'' A variant of this is that we should have a lot of modesty about what to do. My suggestion is that what we should be doing is encouraging institutional arrangements and regulation changes that facilitate the movement of resources out of the industry that is depressed and into an industry that is encouraged by the exchange rate. I think that's very important.
I also would urge that we resist the demand for higher and more generous Employment Insurance benefits in areas where there is a recession, like in Alberta.
Let's assume for a moment — and we can't rule this out — that the exchange rate will stay low for a very, very long time. What we're going to encourage by putting lots and lots of benefits in place to help people temporarily is that they may become accustomed to it. We will get the same as what we have — and many people agree — in the Atlantic provinces: the high generous Employment Insurance benefits having created terrifically bad distortions. It's very difficult to get rid of them once you have them.
I have two positive things that I think we should consider. One of them is already in the pipeline, if I may say: it is the approval of the pipeline. What it does is raises the return to producing oil in Canada. That means they can produce and sell more, they have higher profits, pay more taxes and send fewer people into unemployment. That would be very positive.
The other thing that is related to some of the research and publications that I have done is immigration. For many years we have had a system whereby we reduce the rate of immigration — the number of people who are coming in — when there is economic depression, recessionary conditions, and increased it when the economy was booming. We could set these two levels such that they come to whatever Parliament decides. In fact, the Minister of Immigration and the cabinet decided on 250,000, but it varies according to economic conditions.
This was changed in the 1970s or 1980s because it was so difficult to turn the spigot on and off, but it is now much easier. Communication is easier, as is information storage, and transportation is much quicker than it was at the time. I think we should, as part of facilitating the adjustment that is undoubtedly coming, vary the rate of immigration depending on the economic conditions that are obviously influenced by the current low levels of commodities in the world.
The Chair: Thank you, Mr. Grubel. We will now go to Daniel Schwanen from the C.D. Howe Institute.
Daniel Schwanen, Vice President, Research, C.D. Howe Institute: Thank you, chair. Honourable senators, thank you for inviting comments on the cause and effects of the recent decline in the Canadian dollar exchange rate. A word about the institute:
[Translation]
The C.D. Howe Institute is a not-for-profit, non-partisan public policy research organization whose mission is to foster a better understanding of the policy choices faced by Canadian decision makers, with a view to improving Canadians' quality of life.
[English]
In that capacity I'm very happy to be here. Some of my comments will, no doubt, echo what you have already heard on the topic from my esteemed colleagues.
Let me state at the outset that the price of the Canadian dollar, in terms of other currencies, is one of the most important prices — if not the most important price — in our economy. The Canadian dollar's fall represents the response of myriad actors in the marketplace to Canadians' lower real incomes and purchasing power in the face of a drop in oil and other commodity prices. We are still, in many respects, an economy whose comparative advantage or defining feature, relative to many competitors, is our abundance of commodities. The price of what Canadians sell to the rest of the world, relative to what we purchase from the rest of the world, has dropped significantly, about 10 per cent, since 2013.
Through the lower value of the Canadian dollar the market is in effect saying that, in light of the new commodity price realities, Canadians' wealth, our ability to command high salaries and attract capital is less than what it was. The soft underbelly of our economy, such as relatively poor productivity growth and our vulnerability to debt, is now more exposed. Our customers are willing to purchase what Canada produces, but at a lower price than before. They are willing to invest in Canada, but at a lower price than before. The drop in the value of the dollar represents that lower price.
This very stylized description also explains why the exchange rate between the Canadian dollar and other currencies needs to remain flexible. If the exchange rate didn't or couldn't adjust, businesses and workers would be stuck trying to adjust wages downward to remain competitive. If they were unable to do that, then quantities would have to adjust. Employment and investment would suffer even more than they are now.
We've seen cases, such as recently in the eurozone, where the impossibility of exchange rates adjustments put the onus on wages to adjust for an economy to remain competitive. When wages can't or don't adjust, and the exchange rate can't adjust, the economy suffers through high unemployment.
I should point out that the value of the Canadian dollar also depends on how and what other countries do. It's a price of one currency in terms of another. For example, when the United States, in effect, flooded the world with U.S. dollars as the U.S. federal reserve engaged in what was called "quantitative easing'' back in 2010 as it attempted to revive the U.S. economy, the U.S. dollar tanked relative to other currencies. As was pointed out, now that the U.S. economy looks more solid, the previously looser monetary policy there is being slowly unwound, and the U.S. dollar has been strengthening — and not only vis-à-vis the Canadian dollar, because we think of our exchange rate mostly in terms of exchange vis-à-vis the U.S. dollar. The Canadian dollar's drop against the United States has been more severe than the drop of the Canadian dollar against a number of other currencies, as a recent Bank of Canada study points out.
Canadian production is not the only one becoming more price competitive in our most important market, the United States. We don't have a free pass even with the lower Canadian dollar vis-à-vis the U.S. dollar.
That's my take on the causes and the environment in which we're operating.
In terms of effects, let's take the fall against the U.S. dollar, which is the primary currency against which the Canadian dollar is quoted. As a result of this drop, what we import and is denominated in U.S. dollars is more expensive. What we sell, the cost of which expressed in Canadian dollars, is less expensive for businesses and individuals whose income is denominated in U.S. dollars: i.e., they will be more competitive in the U.S. market.
Not surprisingly, the predicted outcome of a drop in the value of the Canadian dollar, given our productivity levels, wages and other costs denominated in Canadian dollars, assuming those remain constant, if you like, the net impact is to increase Canada's net exports. They are expected to rise, and imports are expected to fall, at least relative to a no- change scenario. This is a key mechanism that will sustain the economy through the oil-price shock we have experienced.
More Canadian tourists will stay in Canada instead of vacationing abroad. Foreign tourists will find Canada more attractive. We are, in fact, already seeing a significant uptick in many export categories, with export performance easily outpacing that of our economy as a whole.
This forced shift away from foreign production and toward Canadian production is not always a blessing for Canadians. For example, a large proportion of Canada's machinery and equipment investment is comprised of imported goods, as was mentioned. They are now more expensive to purchase. So, to some extent, investing in renewal of Canada's production capacity is now more expensive as a result of the lower Canadian dollar, but it is also more attractive because export business, for one, is expected to boom.
The story is similar regarding other internationally mobile inputs for which Canadian businesses have to compete. An intriguing question is whether there are sectors that will struggle to attract talent — for example, in the services industry — when competing against now-more-attractive U.S. salaries. This matters because if we can't make the investment or attract the talent that will help improve our productivity, the dollar will simply fall further in line with our standard of living.
At the end of day, the performance is not an unmitigated blessing, even under the circumstances. There are costs to the lower Canadian dollar. At the end of day, the performance of the dollar, and thus Canadians' purchasing power, depends not only on the price we get for our output on international markets, as was mentioned, but more fundamentally and in the long run on our productivity performance relative to that of other nations.
Consumers will feel the impact at the retail level of higher prices for imported goods. This is part of the adjustment mechanism I described. However, monetary policy's overall inflation target remains unaffected by this. To the extent inflation risks exceeding its target because of higher import prices, corrective action by the Bank of Canada would tend to lend support to the Canadian dollar and dampen the rise in the price of imported goods and services. In other words, there will be no permanent impact on the inflation rate of this lower dollar.
In conclusion, our economy and currency would be in better shape if the price of many commodities we produce hadn't collapsed or if Canada's productivity performance was stronger. However, under the circumstances, a flexible exchange rate is an essential mechanism that will allow non-commodity sectors of our economy to pick up the pace, pushing the blow-in commodity industries and commodity-producing regions themselves and leave Canadians' incomes and employment in far better shape than they would have been had we, for example, operated under a fixed exchange rate.
So we are seeing this benign exchange rate story — in context, obviously — unfolding through a slowly but surely improving net export performance that is sustaining Canada's economy at this very difficult juncture.
[Translation]
Senator Bellemare: Thank you for accepting our invitation to be here. We are glad to have you with us this evening.
Just to recap what you said, the economic times we are living in are abnormal, turbulent and complex. The terms of trade have changed tremendously, and we are in a situation where the challenges around public policy perspectives aren't quite the same as they used to be. I think the Governor of the Bank of Canada said that monetary policy could no longer serve as an economic lever, as it did previously.
Of course, using tax policy to prop things up is an option, but one that has to be exercised with caution, if I took your meaning correctly.
None of you talked about the major infrastructure projects the federal government plans to undertake, representing a $125-billion investment over 10 years and bolstered by provincial, municipal and private sector funding. Perhaps the spending will lead to somewhat of a domestic economic boom, contributing to better competitiveness, productivity and fundamental drivers, and eventually tipping the terms of trade more in our favour.
I'd like to know what you think of this initiative and whether infrastructure renewal efforts are being made in the international arena, given the global nature of the problem. Can we foster more favourable economic conditions, ones that would be more conducive to the resilience of both our and other economies while making it possible to leverage climate change opportunities and cope with the fundamental realities of today's world?
I'd like each of you to take a turn discussing the issue of infrastructure investments.
[English]
Mr. Hodgson: Thank you for an excellent question. I had the chance to appear before the House of Commons Finance Committee yesterday. We had a long conversation on infrastructure, and I will give you the same response that I gave them yesterday.
In the short term we think infrastructure spending is one of the best forms of stimulus for the economy, because our analysis shows that for every dollar you spend, you get more than a dollar benefit for your economy. A typical multiplier would be about $1.20 for $1 spent.
In the near term, it's a great way to, for example, help the Alberta and Newfoundland economies get through the oil-price shock they are experiencing.
But the more fundamental point — and this is your point — is that we have under invested in public infrastructure for probably three decades now, and we have a huge catch-up period. The Federation of Canadian Municipalities puts the number at $177 billion of under investment in municipal infrastructure that then ends in highway systems, intercity bridges, ports and all that. It's really fundamental to rebuild our platform to engage in the international commerce with Americans and around the world. I think it really is a cornerstone of federal government policy going forward. You can't fix it in one budget. It's a matter of making a commitment over many budgets to provide greater public support for infrastructure with all three levels of government acting, ideally, in a very co-operative fashion.
Ms. Yalnizyan: Thank you very much for your question. I'm sorry I can't address it in French.
You are absolutely right that infrastructure can make a difference, should all three levels of government do it. I live in Toronto, and we're having a huge fight about our budget right now. We have $22 billion in things that we want to do that are unfunded. It requires raising revenues at this stage; if we want those things, we have to raise revenues. So, yes, all for it, let's do more. There is some money at the federal level.
If the federal government does roll forward its infrastructure plan we may see more of a contribution, but traditionally the game plan is a third, a third, a third: Everyone puts in a third so things get done. That was our history of building Canada, and I don't expect there will be much divergence from it. As I said, there are a lot of big municipalities struggling to do the things already on the books, much less add to them.
That said any individual year, if they don't roll forward the infrastructure, there's $1.6 billion in federal money for hard infrastructure, $1.6 billion in federal money for soft infrastructure — social infrastructure — and $1.6 billion in federal money for green infrastructure this year. The combination is a drop in the bucket of a $2-trillion economy. We're not going to goose growth with this sort of thing. Even if we double it, it's not going to make a huge difference.
I don't want us to get lost in "stimulus is the only thing federal governments can do.'' One of the things they can do in an era of what I like to call "slowth'' — slow or no growth — is prevent preventable costs from accelerating. We must not only take a look at it not as a multi-year stimulus package, but what can we do now to save taxpayers from spending more later when the cost of borrowing rises and when the cost of labour rises, both of which will happen. Why don't we talk about how we're going to save the taxpayer and not have false economies by saying, "if we balance the budget now we don't have to pay later.'' We'll have to pay more later. What are we doing to prevent the preventable? Our economy, which was in eighth place globally before the recession, is now in eleventh place. Mexico is poised to be in fifth place globally in the next few years. If we don't invest, we're going to become a backwater.
What are we going to do to make sure we are not a backwater on the global stage? Because the global economy is one big supply chain and interrelated. What is our plan to put us at the front of that game? Are we willing to talk about raising revenues to do that? We can't do it all through deficit financing. Some of it we can, most of it we can't.
This raises a different conversation, which is the one you alluded to very briefly. I've seen a couple of articles in the last week. Michael Spence wrote an evocative piece of what it will take to change the pattern of global growth. He also says that what is happening is all nations are synchronized together to balance their books, and that's slowing growth because we have colossal amounts of money sitting on the sidelines — it's what Mark Carney, the former Governor of the Bank of Canada used to call "dead'' money — legitimately not being invested. Investors are saying, "There is no growth. Why would I invest in expansion right now? I will park my money in cash because I don't know what is happening next.''
If everybody does that, there's lots of money and no one is using it. Somebody has to break that logjam, but because we have a fixation on governments being like households, and everybody needs to balance their budgets, and everybody is in deficit so all we can do is cut, we have this stupid double whammy going on where we can't grow because the private sector has no reason to expand and the public sector wants to shrink.
You really do need a change in ethos about what governments are for, and how they are establishing the platform for future growth. That is their role, because public and private sector investment is categorically different; they're complementary. Without public sector investment — like Glen says, $177 billion in unmet, deferred maintenance. Forget about expansion; this is deferred maintenance. Forget about high speed rails, or green infrastructure. For us to meet that so that we can grow with the best nations internationally, we are going to have to change our thinking about what are governments for, and is the smallest possible government is the best possible government, which has been the rhetoric of the last 20 years.
Mr. Grubel: We heard the typical left-wing story of "let's spend more, deficits don't matter, and we will recover it in the future. It is all just an investment.''
I just wonder why we can't have the City of Montreal decide that their infrastructure is breaking down, raise taxes and fix it. Why should we, from British Columbia, send money to Montreal to fix it? Why isn't that a local responsibility?
You ask people around the country, "What do you think we should fix now?'' If it doesn't cost them anything, they have wonderful plans. Not only $137 billion, they have $300 billion in wishes. I wonder what the optimum is. Are we going to decide in Ottawa what the optimal amount of infrastructure is for the country, or should it be a decentralized decision? That's a point I would like to raise for discussion.
The second thing is there was a hint that, in fact, infrastructure spending is good as a countercyclical measure. Historical experience shows that projects that are shovel-ready are extremely small. There are not many to go; they would have gone anyway. We want to add some, but it takes a long time to get environmental and other kinds of government approvals in order to build something — infrastructure. Experience has shown that typically by the time it gets approval we have a boom and it will add to inflation. I just want to tell you that this is historical experience.
I am very skeptical, but I am concerned, like everybody else should be in this world, about why we have — especially throughout the western world — such a slowdown in economic growth. You have to be careful when you discuss this because it depends, to a large extent, on population growth. You can have lots of population and economic growth, but that's not what we're talking about. In Canada, the United States and Europe what we need is what is known as "total factor'' productivity increases. That is, we get economic growth in our market economies when a worker who is making $100 this year, and next year earns $102. It is not inflationary, but his productivity increased by $2, and the same amount of capital gives more output next year.
How do we get this increased output from labour and capital? It's innovation. It is people developing new products, better technologies and so on.
Why have we not been getting those innovations? Everybody is talking about, and putting money into, development centres for breeding new ideas. It's not taking place. One explanation is that they can't sell them. That has never stopped them in the past.
I think what we have done in the western world is we have killed the goose that lays the golden egg by excessive regulation.
I had lunch with a guy at Whistler a couple of weeks ago. He used to sell food for salmon farming enterprises, and he and his buddy discovered that there's a big problem in British Columbia in getting rid of the debris from the many hot houses that we have. They came up with the idea to put them in a box and put in some eggs from insects that will eat it. What a wonderful way of recycling. They then take the insects and make them into little cakes that can be sold. Dogs love them and they can be used as fertilizer. But the big market is in fish food. There is no regulation in the United States that prevents the sale of insects for fish food.
This guy tells me he has been dealing for four years with the regulatory authorities in Ottawa to get the permit to sell those things to the farmers. That is how, and you can multiply this by other stories, this regulatory environment has killed the goose that used to lay the golden eggs.
[Translation]
Mr. Schwanen: My answer is on the shorter side, given how much has already been said on the subject. I agree with the witnesses who think that infrastructure spending has a positive impact, albeit limited to the short term. The real question is what the impact of that infrastructure spending will be in the long run. It all depends on the infrastructure projects selected. It's, very often, the focus of our work. Will those dollars facilitate exports or improve our productivity and ability to compete? Will the money be invested in bridges, border infrastructure or even pipelines? Those are the investments that will improve Canada's capacity to generate revenue and high-paying jobs for Canadians.
As far as physical infrastructure is concerned, spending the money is very important, but choosing wisely is key. It's even more important than the total dollar amount being spent. That's all I have to say for now, but I would be happy to give you more details if you like.
[English]
The Chair: I would ask you all to keep questions and answers shorter so we might get through this before 6 o'clock.
[Translation]
Senator Massicotte: My question is for Mr. Hodgson and Mr. Schwanen, since we already know Ms. Yalnizyan's opinion.
A close look at the entire world, especially Japan, has given rise to theories on economic growth and monetary policy. A number of countries, however, have trouble creating an acceptable level of growth. So the question is do those theories still apply. Perhaps we're in a different age. Perhaps we'll experience a hundred years of fairly low growth, or perhaps we are wrong about the way to manage the economy.
Mr. Hodgson and Mr. Schwanen, are you concerned about that? Should we be preparing for low growth, given Canada's demographics, as well as those of Europe and elsewhere?
[English]
Mr. Hodgson: Here I would agree with Mr. Grubel. I would say that productivity growth is the magic solution. The trouble is that we have been a lousy performer for 25 years in this country. Our productivity growth rate is a whole percentage point below the Americans for the last 25 years, and there is no silver bullet. There is no simple solution.
The Chair: I might add that we've been talking about that in this committee for the last 20 years, at least.
Mr. Hodgson: Absolutely. We tend to look at sort of a suite of activities, and no one of them alone is going to solve the problem. You probably have to do all of them.
Arguably, our governments have gone two-thirds of the way forward in terms of the policies that they could change. We've had tax reform and pursued international free trade. Minister Bains has already talked about getting rid of barriers between provinces. We may have entered a period of, frankly, secular stagnation, where it is much harder to create growth. Focusing on that kind of growth, ideally on growth that is widely shared across the economy, should be driving our thinking, our budgets and almost every aspect of policy-making, but there is no silver bullet.
It is absolutely true that demographics drive the underlying growth potential but a country like Japan, for example, is only growing because of productivity growth. Many other industrial countries are going through the same experience. There is no quick fix. Thinking hard about things like innovation, bringing new products to market, how to actually feed the integration process, is part of the dialogue and the conversation.
[Translation]
Mr. Schwanen: There is still some good news in the world. Some countries, like India, are experiencing accelerated growth. Even Africa is faring pretty well these days. Some countries, then, have found the right formula. Obviously, they aren't in the same boat as Canada.
Picking up on what my colleague Glen said, I would say that, to some extent, we missed our chance. We had all that oil revenue and, yet, we did not reinvest it in those areas that would have allowed us to increase our productivity and foster innovation through research and development. Nor did we reinvest it in important segments of the Canadian population that have trouble adapting to a technology-driven economy, owing to literacy and numeracy issues, for instance. If people don't keep up with the changing pace of technology, and vice versa, we are going to have problems on our hands.
I wouldn't throw in the towel just yet. We again have an opportunity to reinvest in programs and infrastructure that will generate better economic growth, so that we can deal with our fiscal challenges around the aging population more effectively. There are things we could have done and didn't, but it's never too late to make the right decisions.
[English]
Senator Marshall: I want to go back to the stimulus spending. When we talk about stimulus spending, why do we always talk about spending money on infrastructure? If the government is going to provide a certain amount of funding, hopefully there's a limit to how big a deficit they're going to run. Why is the emphasis on infrastructure? Is that where we would get the biggest return for the problems that we're having, or would it be better to put money into, I don't know, Bombardier? Why is the focus always on infrastructure spending? Is that where you would get the biggest bang for your buck?
One of the witnesses indicated that it would be beneficial more in the short term but not in the long term. Why does everybody focus on infrastructure? If you're going to use stimulus, and I'll not say that I would support a lot of stimulus spending, does it have to go to infrastructure? Why do people always focus on infrastructure? Is that where we're going to get the biggest return?
The Chair: Does anyone want to answer that?
Senator Marshall: I have another question if no one can answer that.
The Chair: I think they'll answer that.
Mr. Hodgson: Maybe I'll start briefly. First, the multipliers are strong in infrastructure spending. They're also very visible; it's good politics.
There are other programs you could use. For example, I really liked the home renovation tax credit put in place in 2009. It got a lot of working folks back to work very quickly. It also allowed people to bring forward spending that they might have spent anyway. It was a very effective program for a short period of time.
Senator Marshall: More people think they benefit.
Mr. Hodgson: EI reform is another, if it could be done quickly. Clearly Albertans are facing a barrier with respect to getting access to Employment Insurance. That is another thing that could be done fairly quickly which will give you good payback. If you do the raw analysis, as we do every day, spending on infrastructure gives you good payback for every dollar spent.
Senator Marshall: One witness said that it's only in the short term, not the long term. That's not correct, is it? It is in the long term.
Do I have time for another question?
The Chair: Does anybody one else wants to take a crack at that? If not, quickly ask the question and we'll go on.
Ms. Yalnizyan: I wonder if I could weigh in briefly on the exceptionally interesting question about whether we should invest in Bombardier. I think that is one of those impossible questions to answer, because market conditions are changing rapidly for Bombardier and it's unclear what the future will hold. I'm glad I don't have to make that decision.
However, if we lose Bombardier we are looking at an impact on the Quebec economy that is larger than the impact of what the situation was for auto in 2008 in Ontario. It would have a huge ripple effect on the national economy.
It looks like it's dead easy to answer that one. It's like: Why would you do it? But it's not that dead easy yet.
Just in response to your question about why you would do something that is only good for the short term, infrastructure is the opposite of doing things for the short term if what you're talking about is hard infrastructure, which has a life of 20 or 30 years. I don't know where you live, but in large cities the gridlock we are experiencing in transportation because we do not have enough affordable housing and people are moving further and further away from their jobs is delaying businesses and workers and costing us a fortune, and we haven't figured out how to solve that.
So, if we figure out how to solve it, you get the markets functioning better, as well as laying down a foundation for the future.
Senator Marshall: Could I have a question on the second round if we get there?
The Chair: Yes, absolutely.
Senator Enverga: About the U.S. dollar and the Canadian dollar, there's always a debate on what is the best dollar rate that we can ever have. I know that when our dollar was high, one complaint was that nobody buys our goods, and then when it is low we need more help with this.
What is the ideal value of our Canadian dollar, given the fact that we're always trying to make it equal to the U.S. dollar? I'm thinking about Herb's comment about the American dollar. Is it better for us if we adopt the U.S. dollar? Is that possible? What is going to happen if we do that?
Mr. Grubel: That question was always posed to me when I proposed the creation of the "amero,'' with all the benefits it would bring. I just recently had a phone call from the chief economist of one of the big banks, former dean of a business school. He has been getting all kinds of feedback from industry saying, "We are absolutely devastated by this seesaw in the exchange rate. For us to plan business is just very difficult and costly.'' They would say it was far worse to have this.
My answer to that is but, of course, I don't know what it is. We ought to have a long discussion if we ever were to go into making it a one-to-one rate, whether we will exchange the Canadian dollar for 90 cents or for $1.10 or whatever. I don't really know. The main point is that the increased certainty of not having the seesaw rates in our trade with the United States would encourage investment, specialization, level of trade and capital flows. It would be a tremendous benefit, I think, just like Ontario has a lot of benefits from having a market in which there are no fluctuations in prices, in Manitoba and in British Columbia and so on.
That's the essential argument. It's very abstract and academic. I just wanted it as a counter to his idea that a freely floating exchange rate is a solution for everyone.
Mr. Hodgson: Well, two small comments. Most economists think that the exchange rate at 85 cents is purchasing power parity, if you look at our analysis, that of the IMF and the OECD. But, of course, we're never there because the exchange rate is set on the market every day. We kind of pass through it on the way up and on the way down.
I could spend a lot of time rebutting fixed exchange rate symptoms. I think if you ask citizens in Spain, Greece and Italy about the benefit of being part of the euro, you would have a resounding rejection of a fixed exchange rate system within Europe, but we're not here to talk about Europe today.
The Chair: Mr. Schwanen, did you have a comment?
Mr. Schwanen: No, not really. I agree with what Glen said both about purchasing power parity and the dangers of a fixed exchange rate. You're losing your flexibility, and that is even more important than having the benefits of more certainty that Mr. Grubel described. I'd say let's not lose our flexibility via fixed exchange rate.
Ms. Yalnizyan: The only thing I would add to this conversation is that nobody knows what Canada's value is relative to the U.S., and it changes all the time. If we were talking about an "amero'' a few years ago when we were above parity, would that be the right time to lock it in?
It's hard to have something fixed when the market is constantly changing, and different elements of it are changing. It now looks like, for the Canadian economy, that if we don't pivot to a different type of energy base we are looking at a long-term low dollar the way the market would value it.
Senator Enverga: I know some countries like Ecuador, El Salvador and some small countries have adopted the U.S. dollar. Do you know what happened to them? How is their economy? Are they faring any better than anyone else?
Mr. Hodgson: For the most part, for countries that adopt the U.S. dollar, their currency has gone through a disaster. They have no other anchor in their economy, so they basically default to the U.S. dollar. Zimbabwe would probably be well advised to adopt the U.S. dollar as their currency because their country is a disaster.
Mr. Grubel: I once asked Milton Friedman — I used to teach at the university of Chicago — what he thought about Mundell's argument for optimum currency areas. I asked, "If it's so good for all countries, would you recommend that Panama has its own currency?'' He said, "No. They did the right thing by adopting the dollar.'' Panama today is one of the most prosperous countries of Central America. One reason is because the politicians cannot tell the central bank to finance their overspending like they did in Spain and in Greece. I have written a lot about this. The people of Greece will someday be grateful for having been in the euro because they had politicians that constantly overspent and had their central bank print currency. They had inflation, and it was a very stagnant economy.
There are long arguments on both sides, and I'm just giving you a hint of what some of them are.
Senator L. Smith: Thank you very much for your participation today. I'll try to make this as short as possible.
Senator Massicotte, I think, started a question that spurred me on. You're locked in a room, four of you, including our esteemed guest who is far away in a television studio, and your mandate is the following: Each of you has to come up with one single factor or step or policy that you would stake your claim on to help move our country forward in terms of reinvigorating, reenergizing our economy, knowing that we are in the global market and affected by many, many, many issues outside of our control.
What I'm asking is for each of you to come up with your number one step or implementation that you would do if you were in a position of authority to make it happen.
Now, I know economists. I'm an economics major too, and I remember we used to have arguments in our fourth year with our teacher. There are five of us in the class, international economics, and we'd be drinking and having a great time and theorizing forever. But is there some practical means by which we could take a look at this?
Ms. Yalnizyan: I'd bring in a 10-year plan to deal with that $177 billion worth of deferred maintenance that needs to be fixed now. It would get more expensive down the road. If we fix it, we can build and expand on it. I would have a 10- year plan clearly delimited. What are you going to do? When are you going to do it? I would raise taxes to do it. I wouldn't do it through deficit financing.
Senator L. Smith: Deferred maintenance is defined as what, please?
Ms. Yalnizyan: All of the stuff that the Federation of Canadian Municipalities has identified.
Senator L. Smith: Okay, so you're talking infrastructure.
Ms. Yalnizyan: Hard infrastructure. I'm not even talking about green infrastructure or social infrastructure, just fix the platform for growth that businesses, families, everybody uses.
Mr. Grubel: You asked a question which I often use and find out a lot about people's thinking. It's a very good trick.
I think that one of the great deterrents of investment and people's decision to spend, which would drive the economy, is uncertainty about the future. What is one of the great uncertainties right now? Well, we have just signed an agreement to dramatically cut back greenhouse gas emissions. What is it going to mean for industry? Are they going to have to cut back a lot? Are they going to be in trouble or will it stimulate them?
We have now a government that says, "Oh, you know, a little deficit spending that keeps the ratio of debt to GDP okay,'' you know, never mind about the fact that it's very difficult in the future to cut back with growth and we don't really know what the economic growth will be so that the GDP ratio will be what we predict in the future.
There are a lot of people in Canada who are very skeptical about the merit of getting into a cycle of deficit spending again. We took a long time to get out of that. I was part of the movement in 1993, the Reform Party, which brought about an important change in thinking, which brought us 10, 15 years of prosperity when other countries did not take the deficit down to where Chrétien did at that time.
There is all this uncertainty that is being created by government policies of intervention that are very destructive to consumer and investment spending. That's my answer.
Mr. Schwanen: I'll just say in passing that I agree with Mr. Grubel that a lot of sectors of our economy are overregulated and we need to let them loose a little bit.
We need to come to terms with the fact that we are still largely a resource-based economy and come to terms with our destiny really as a trading nation. Right now we seem to be hesitating on both fronts, whether it's a pipeline or trade agreements, and somehow we have to build some kind of social acceptance, if you will, as to how we move forward on energy, infrastructure and trade.
Speaking of infrastructure, I agree with Armine that the cost of congestion is terrible. One thing I would say about infrastructure is that living in a big city obviously it is extremely costly for the economy as a whole. The urban space doesn't generate for governments the revenues that it should be generating because of that problem.
I have a couple of notes on infrastructure spending. I will end on my stronger point, which is on infrastructure spending. Number one, it can improve long-term productivity in the economy; number two, it's easier to finance. You don't have to debt finance infrastructure spending. If the federal government wants to increase its infrastructure spending, it can amortize it over a very long period of time for the duration of the infrastructure. It doesn't have to go into deficit figures.
With respect to urban economies, the formula we're looking at right now — we will have a paper in the next couple of weeks on that — is a financing formula for infrastructure called "tax increment financing'' that we're suggesting for Toronto and that others could adopt.
Again, funding for infrastructure, first, it has a positive impact if you choose the right type of infrastructure and, second, it's easier to finance than other programs.
Mr. Hodgson: I will give you one answer, and a short one. Investing in people is the single most important thing we can do. The fact that our Aboriginal kids have a high school graduation rate of less than 50 per cent is shocking. If there is one thing I would do, it's everything possible to ensure that Aboriginal kids get the same high school graduation rate as everybody else. Aboriginal high school graduation in a province like Saskatchewan is probably 45 per cent.
Mr. Grubel: How are you going to do it?
The Chair: That's a question for another day, Mr. Grubel, only because I've been here a long time.
We've discussed the question of productivity. I remember the Governor of the Bank of Canada, Mr. Dodge, coming here and we'd ask him, "Why is the dollar 65 cents?'' and he'd go through this whole thing, it would all be based on commodity prices. But, really, Canada faces a difficult problem, and I'd like your comments on this. Oil prices have been determined by a kind of giant egg marketing board — a cartel. I'm a big believer in the market, so I knew that sooner or later the cartel would be broken by innovation.
The only thing that prevented me from becoming a billionaire is not knowing when, but I believe in the market and I believe that sooner or later that cartel will be broken. We had economic growth and investment on a price that was fixed by a bunch of Arab nations who controlled production and the economists weren't talking about it — no one was talking about it — and the fact that this was a false price. This is like raising the price of tomatoes to $100 when everybody needs tomatoes to live. Well, guess what? That's a problem we have.
The 78-cent dollar, the 75-cent dollar and 74-cent dollar will not help productivity because this gives our manufacturers a 40 per cent advantage, so why would they invest? Why would they become more productive?
How do we balance the two? The question of the price of oil is not really the price of oil. The price of oil is what it is today. That's what it's going to be. And it may be $12 a barrel once Iran starts pumping it out, so we shouldn't be counting on investing in $100 oil again because it will not happen unless they fix the price. The 72-cent dollar won't help us gain productivity, so what are we to do?
Mr. Grubel: I would say that the price could also be $200. If we have a big explosion of military conflict in the Middle East it might go to that. We really don't know. But as Václav Klaus said, "If we knew how to deal with these things, communism would have worked.'' We don't. We have to encourage markets so that people can react at a decentralized level. They may all be making individual decisions that may be wrong but, on balance, it's their money they're putting in there, and the worst thing we can do is believe that someone in Ottawa or Washington knows the right price. I fully agree with you. Nobody had foreseen fracking. That's what set it all off, and heaven knows what's around the corner.
I had an email from a student the other day. He said, "Professor Grubel, when you were lecturing on prices of energy you said you didn't know what the prices will be. They could be very low in the future. We could have a flood of oil products,'' and he said, "Everyone in the class said 'he's crazy,' and it turns out you were right, we just don't know.'' And yet so many people are prepared to say this is what's happening.
The question of instability in prices is in everything: cars, vegetables, wheat and fish. Everything is unstable. Can we do some planning to eliminate it? I don't think we are very good at it. As Stephen Poloz said, we've got to live with it.
Ms. Yalnizyan: I want to make a comment on why productivity doesn't seem to be giving us the payoff that traditionally it did. In an economy that was agrarian and became mechanized, we saw a huge increase in quality of life and standard of living. When we went from an agricultural to an industrial society, we saw a huge increase in the quality of life and the standard of living.
We are in some new wave of innovation, and it's awash everywhere. But its result is providing free things for the market: free things everywhere. That's one of reasons why there is such slow growth and not translating into better incomes for individuals or higher prices. So much of the wave of innovation that we are in the midst of is not about capturing a price from the market. It's flooding the market with opportunities we have never seen before. Consequently our models of how to capture productivity, how do you measure it? How do you translate growth into widespread prosperity?
The Chair: Give me an example.
Ms. Yalnizyan: Anything to do with IT; anything to do with music; anything to do with artificial intelligence; and the way we are now doing science research. Take a look at citations from medical studies or pharmaceutical studies, bona fide ones, and you have a cast of thousands. It's like a movie-credit list. The number of people contributing to advancing knowledge and product is now not individuals and individual patents, it's a wiki process. It is a process taking place in real time.
I'm not saying it's free, I'm just saying a lot of innovations and developments we're doing are not "monetizable.'' Twitter and Facebook are going nuts. Some of the biggest companies in the world don't know how to monetize the thing they have with billions of users. More than half the world is using their products, and they can't figure out how to make a profit out of it. We are in a new era, and it has a new dynamic of how we measure productivity.
The Chair: But they either make a profit or they're going to go broke.
Ms. Yalnizyan: They make profits —
The Chair: There you go.
Ms. Yalnizyan: — but they can't grow. The issue is growth. The issue is not making a profit or being viable, the issue is that shareholders want the old model of getting 4, 5, 8 per cent returns. Companies know how to deliver that. They do so by containing costs, which means cutting people, cutting wages, cutting inputs and figuring out a cheaper place to do it. There is an end game and you can't do that endlessly.
The new normal is you have a lot more stuff than you used to have, but you can't continuously reap rent out of it at the same rate as previously. We are seeing a new economy emerging out of the stuff that generates productivity, new ways of doing things anyway, but we haven't figured out how to harness it yet.
I'm saying we're living in a new economic reality that we have not figured out yet, and it's colliding with population aging which guarantees people will spend less money. Everything is leading to people spending less money, which means less growth and harder-to-capture profit. We are being challenged to think about what the economy is for and who it's for in a brand new way, in a way not seen since the agricultural revolutions. There's something new that is happening.
The Chair: You know, I don't want to get into an argument on this, but money doesn't disappear because you are spending less of it. People will spend it on something else.
Ms. Yalnizyan: No, we are dealing with a cohort of retirees, people who are too old to work, that is the biggest we've ever seen on the planet in China, the United States, Europe and Canada. We'll see a major drop in their income and we're going to have to adjust to the fact that a bigger share of the population literally cannot spend as much as they did because their incomes are lower. At the same time, young people are looking for free everything. They're getting less money than ever and they expect everything to be free. There is a lot of money washing around in the world, don't get me wrong, but it will not grow at the same rate.
The Chair: The mortality rate will look after the old people.
Mr. Hodgson: It is hard to add value in this conversation by finding something new and clever to say on top of that, although I really enjoyed Armine using "profit'' and "monetization'' in her comments. I think that's a first, and I enjoyed that a lot.
Fundamentally the challenge is how you become a price maker and not a price taker. Part of the reason we are suffering as an economy right now is because we became a price taker, and the price collapsed.
There are sectors, for example, which are growing well. We are doing research right now in the service sector. In Canada 70 per cent of GDP are now services. The challenge is to become a global leader in all sorts of services where you can actually capture the benefit.
We have world-leading life insurance companies, for example. In some sectors you can point to great success.
Senator Marshall: This is my second question. Negative interest rates, we keep hearing about them. What impact would that have on the economy?
The Chair: What are they, first of all? What are negative interest rates?
Senator Marshall: A, keep your money in the bank.
Ms. Yalnizyan: It's for the banks, not for you and me.
Mr. Grubel: If it were to spread beyond the banks, if you have a $10,000 nest egg ready to spend if you get ill or have a car accident or something, cash reserve, the government says next year it will be worth only $9,900. It is a tax on balances in the bank, and the idea is that it will give an incentive to spend.
Could I say something about services? There is a widespread misunderstanding about the nature of services. The vast majority of services are not McDonald's, haircuts or restaurants. The vast majority of services are professional services. The vast majority of professional services are embodied in goods that are exported. We don't have to export. It's nice that we have some life insurance companies that are exporting their services, but a lot of services, professional services — research, marketing, engineering, transportation and all that — are going into natural resources.
So when we expand manufacturing now in response to the shift of resources from natural resources into manufacturing, it really gives a big boost to professional income, and professional services are being absorbed. The reason we have this tremendous growth in the income of those professionals is that their productivity has gone up by being able to do this.
Mr. Schwanen: I'd say ultimately productivity, in an old-fashioned way, is linked to investments. In that respect I'm a bit of an old-fashioned Keynesian. It's the animal spirits. If investors don't see the opportunities they won't invest in a new plant, machinery or equipment, and if they don't know, or if the future is clouded, as I think it is now by some of the factors that have been discussed.
I think that's the tough nut to crack, how to spur private-sector investment. We've been trying in different ways, but it all comes back to investments. Not just machinery and equipment, but skills, workplaces and so on. Infrastructure and public investment to some extent is a substitute or can help spur private investment, but if we don't see the private investment it will be hard to see the increase in productivity. That may be a bit of an obvious observation, but that's really the difficult question mark right now hanging over the economy, globally even.
[Translation]
Senator Bellemare: I have a quick question for you. I'm trying to figure out how we can protect ourselves against uncertainties.
According to previous witnesses, thanks to the value chain and globalization, many companies now have the ability to protect themselves, and the fluctuating loonie can help maintain a balance of sorts, owing to activities that are shared across the world. At the end of the day, the risk is not as high.
Is the risk lower now than it was in the days when globalization was less common? In other words, can fluctuations in the value of the dollar help companies protect themselves better than before?
[English]
Mr. Hodgson: You're right, there are firms in Canada that are investing offshore as a way to diversify their business operations around the world, but I would argue they're basically swapping one risk for another. Maybe they are benefiting in terms of the exchange rate risk, but they're taking other kinds of risks, such as taking control of their supply chain, for example, or the value chain — country risk that they wouldn't be exposed to.
You have to look at risk as a complete story. If the one that matters most to your business is the exchange rate, then you diversify your business by investing in the U.S., for example, so that you have a hedge built into your business. It reduces that risk but you might encounter other kinds of risks that you'll then have to manage. The risk of litigation in the U.S., for example, would be for me a serious risk to have to manage.
Senator Bellemare: Pooling risks, like you do with insurance, might not bring certainty but could decrease, for the individual, the experimentation of flexibility in the environment.
Ms. Yalnizyan: The whole concept of pooling risks is done in large corporations getting larger. They vertically integrate and manage their risk by bringing in more suppliers. It depends on how you look at risk and how the risk gets shifted. Often they shift risk to their suppliers and contractors, which actually increases the risk throughout the supply chain for companies. You were talking about being a price taker previously. There are more price takers in the system and fewer price setters. They are more ruthless in the way they set prices; and those prices are coming down. There's accelerating risk in this global supply chain game, where more and more companies are finding same-store sales falling. One of the ways they lure more sales is by cutting costs, and they pass those costs onto their suppliers. It's a lot of kicking down the chain.
Whereas large companies are minimizing risk because of their ability to tap into the supply chain, the elements of the supply chain are seeing the risk devolve to the level that can least absorb the risk when things go bad.
Mr. Grubel: We live in a dangerous and risky world. We have been doing very well. We have the highest standard of living that Canadians have ever had. The world is better off than it has ever been. We have always had new challenges, new risks, the economy — a free society has dealt with it very well. The greatest threat to our future prosperity, in my view, is that we have too many do-gooders who think that we need some heavy hand in Ottawa or in Washington to try to deal with these problems, which we have dealt with so successfully in the past, into the future and, in the process, prevent the kind of freedom of adjustment, of expression, and introduced political correctness to prevent expression of views that are not consistent with the current prevailing view.
Everybody says that infrastructure is the solution. Give me a break. There are no simple solutions to any of these problems. We know that when we had decentralized decision making, we had a tremendous amount of prosperity.
China was in a situation, and Japan, where 80 per cent to 90 per cent of their population were highly unproductive in agriculture. Then suddenly, they opened up their markets and said, "We should take advantage of what the world has already developed.'' They invested in the latest technology we had; and there was this tremendous boost in economic growth.
But Japan had the same problem, aside from aging, as China will have very soon: economic growth after a certain point, when they have all our technology that they have stolen, by innovation of the sort that I discussed — increased factor productivity.
Whenever somebody comes up with a new product in our society where we have strong representation of the people who will get hurt by this innovation, they can prevent it, while in China what is there? There are state-owned enterprises that have a lot of political connections. If an entrepreneur in China wants to do something that damages the interests of those industries, they go to Beijing and get killed. Unless we get, in China and Japan, greater institutional arrangement practices that allow equilibrium-disturbing innovations, we will see the kind of stagnation that Japan has had and China will have.
In Why Nations Fail, the person investigated a number of important countries. In each case, nations failed because institutions developed with the help of government, which prevented competition from the established interests. We are in danger of doing this in order to eliminate risk or whatever cause there is.
I think that is one of the greatest threats, in addition to reducing our freedoms.
The Chair: Thank you. We definitely had a variety of opinions today, I have to say. It was very interesting, and we enjoyed ourselves very much. Thanks to all of you.
Senators, we'll say farewell to our witnesses and guests with a quick handshake and then go in camera for about 10 minutes.
Senator Day, could you stay since we don't have any opposition members?
Senator Day: I wish I could, but I'm speaking at a gathering.
(The committee continued in camera.)