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How will the Trudeau government handle challenging economic environment in 2016?

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Justine Trudeau

 THUNDER BAY, ON  ---   January 17, 2016  ----    The Trudeau government has a full agenda on its plate for 2016 given the global political and economic environment, as well as its own list of election promises.  

Yet, the fundamental issue that Ottawa must deal with is simple: how Canada will continue to make its economic way in the world given the end of the commodity boom and the tightening of global credit markets. With a lackluster Central Canadian economy and a depressed Western Canadian resource sector, rising interest rates will reduce what has been an important source of stimulus for the Canadian economy.

The U.S. economic recovery marks the end of a cheap money cycle that has fuelled Canadian housing construction and consumption via the acquisition of record amounts of consumer debt. Canada’s household debt burden hit a new record high in the third quarter of 2015 as the ratio of household credit-market debt to disposable income rose to 163.7 per cent. Total credit-market debt reached $1.89-trillion in the third quarter of 2015 with mortgage debt making up $1.23-trillion of that.

Moreover, cheap credit has also allowed many governments at the provincial level to live beyond their means by running large deficits and adding to their debt. Provincial government net debt in 2014-15 totalled $568 billion while federal government net debt stood at $687 billion making the combined federal-provincial net debt-to-GDP ratio nearly 65 per cent. Moreover, the Trudeau government is embarking on a fiscal path that will see infrastructure spending funded by annual deficits possibly as high as $25 billion—if not higher. However, these deficits will not have the anticipated stimulatory effect on the economy.

The recent U.S. Federal Reserve decision to raise interest rates a quarter point will be followed by other increases and ultimately generate higher borrowing rates for Canadian homeowners, consumers and governments. The additional debt servicing costs at the consumer and government-sector levels will result in significant negative drag on the economy at a time when it already is not firing on all cylinders. The resource sector bust resulting from lower oil and commodity prices has yet to be counterbalanced with a resurgence of the Central Canadian economic heartland that stretches from Windsor to Quebec City.  

Canadian economic growth in the final quarter of 2015 appears to be slowing and a drop in our exports in October may be further evidence of this. Particularly troubling is the fact that despite a depreciating Canadian dollar and a resurgent U.S. economy, October saw a drop in Canadian exports to the United States. This suggests that the one silver lining of rising U.S. interest rates—further depreciation of our dollar that can stimulate our exports—may do little to that effect.

In the wake of the 2008-09 recession, there appears to have been a structural shift in the U.S. export market making it much more competitive for our firms. Many of the manufacturing jobs lost in Ontario and Quebec over the last decade will not be coming back, despite a lower dollar.

What is a federal government to do?  

In the end, Canada needs to boost its economic productivity and a key component of that is private-sector investment. With the drying up of business investment in the resource sector, investment in capital equipment and machinery needs to be encouraged in other sectors of the economy. Such investment requires business confidence and the prospect of a new era of federal deficit financing may be unsettling the business community especially when juxtaposed against the poor public finance picture in Alberta and Ontario.  

Even the prospect of small deficits relative to GDP may generate substantial investor uncertainty in an environment where interest rates are on the way up thereby increasing the possibility of future tax hikes to service a rising debt burden.  

The best federal government response to a challenging economic environment in 2016 is responsible public finances and a competitive tax environment.

Author:
 Livio Di Matteo

Fraser Institute

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