In this week’s The Seven…

• Reboot - Kickstarting Canada’s economic engine
• Crude awakening - Oil prices under pressure
• Close call - Bank of Canada pause 
• Delayed - U.S. jobs resilient…for now
• Interesting Fact: Canada’s lagging innovation performance
• Chart of the Week: Low R&D - Another piece of Canada’s productivity puzzle

With a quieter week on the tariff front, the federal election stole the economic spotlight. On Wednesday we talked about five big challenges the new government will face. Today, we focus on the second one: productivity. We begin with a speech that Mark Carney himself gave in 2010 when he was the Governor of the Bank of Canada. For further insight, ATB Capital Markets discusses what the election means for various sectors.

Still lurking - Productivity problem hasn’t gone away

“We have a second, much bigger problem: our abysmal productivity record. Over the past decade, it has averaged a paltry 0.7%, about half the [growth] rate recorded over the 1980-2000 period.”

The Virtue of Productivity in a Wicked World, Mark Carney, Remarks to the Ottawa Economics Association, March 24, 2010.

If I were in an elevator with Prime Minister Mark Carney, I would ask him one question: What’s the plan for reversing Canada’s dismal performance on labour productivity?

Carney knows the importance of this. His 2010 speech came almost a decade and half before the now-famous 2024 “break the glass’’ productivity emergency talk by Carolyn Rogers, Senior Deputy Governor of the Bank of Canada.

Since Carney’s 2010 speech, Canada’s performance has remained lacklustre. Annual business sector labour productivity growth has averaged only 0.3% over the last decade (see the chart below).

Comparing the speeches, it’s remarkable how many of the problems identified are the same: low business investment, a higher proportion of smaller firms, lack of competition, skills mismatches, etc.

Reframing productivity - What will drive Canada’s economic growth?

Even before Trump 2.0 stole the spotlight, productivity suffered from a communications problem.

To many, it’s an esoteric concept. People don’t necessarily ‘feel’ the impacts of low productivity every day. It’s also a slow burn—over time, lower productivity erodes living standards, but maybe not today or tomorrow. That makes it less likely to be a kitchen-table discussion and therefore less likely something politicians will tackle immediately.

Let’s try something that’s more relatable—growing the economy. Productivity is just a component of that (the most important over the long-run, but let’s put that aside for now).*

So what will drive economic growth in Canada? Consider the options.**

Households can continue to spend more. But there are challenges. First, they are still recovering from the high inflation and interest rate period, and face higher rates than before as mortgages reset. Interest rates are coming down, but will stay well above COVID levels. Second, Canadian households are also among the most heavily indebted in the G7 based on debt to income. Third, population growth is abruptly slowing. In short, we can’t count on the consumer to drive growth. In terms of government spending, it has already increased sharply, and the Carney government is promising even more spending. There are limits (higher debt, taxes) to how much the government can drive growth through spending.

Business investment seems like a good candidate for re-invigorating growth. Its decline is a big reason GDP per capita has hardly budged over the last decade. A major part of this is oil and gas investment plummeting in 2015-16, and remaining well below 2014 levels. But it runs deeper than that. Statistics Canada notes that investment weakness has been “pervasive across industries.” Investment in machinery and equipment has been trending lower on a per capita basis. In 2023 (latest available), real investment in the Canadian manufacturing sector was still below 2000 levels. Overall, Statistics Canada finds that weakness in investment is largely responsible for the productivity slowdown since 2015.

Some may be less worried about the ‘bricks and mortar’ investment problem, noting the shift towards services with more emphasis on intangible knowledge capital. But the C.D. Howe Institute has found the gap with the U.S. has also widened significantly for investments in intellectual property, along with M&E. R&D spending continues to lag most OECD countries (see the Chart of the Week), and Canada also underperforms using broader measures of Canada’s innovation outcomes (see the Interesting Fact below). This hurts Canada’s performance on multifactor productivity—a proxy for innovation.

Canada also needs to build more homes. But these are not productive assets in the same way as a new mine, petrochemical facility or auto assembly plant. Today, the stock of housing assets now exceeds that of non-residential assets, which does not bode well for future productivity gains.

Trade is another area for improvement. The volume of exports, on a per capita basis, has hardly budged since 2000. More can be done to expand access to overseas markets, reducing dependency on the U.S. Part of this is building infrastructure and transportation corridors, as was done for the Trans Mountain Expansion (TMX). The other part circles back to business investment. Without investment today, you’re not going to have the capacity to export in the future.

So back to the original question: what will drive growth?

It seems pretty clear to us that the next leg of growth will need to be driven by private capital investment—both physical and intangible. On top of that, the country will need to find ways to boost its innovation performance. The combination would result in a much-needed improvement to Canada’s languishing productivity performance.

*There are two ways to grow the economy: more hours worked (people) and more output per hour worked (productivity). Without the workforce becoming more productive, you’re relying on hours worked to do the heavy lifting. Increasing workforce participation is critical, but there are limits to this as a growth driver, especially as aging forces more people into retirement and as population growth slows.

**From Econ 102: GDP is the sum of household consumption, Investment, government spending and net trade (exports less imports).

Rearview mirror - Alberta outpaces national economy in 2024

Under the category of ‘that’s so yesterday’, it’s still worth sharing new data revealing how much Alberta’s economy grew last year.

Alberta’s real GDP rose by 2.7%, faster than the national gain of 1.6% and tied for third with Nova Scotia after PEI and Saskatchewan. Not bad given the interest rate headwinds, though it's still below the blistering 4.4% population growth that year.

The contributions came from both the goods and service sector, each accounted for roughly half the growth.  Within the goods sector, energy led the charge as oil production ramped up under TMX.

This is almost bang on with our 2.5% call we’ve had since November (cue self-congrats)—well done to ATB economist extraordinaire Sid for getting us so close.

Crude awakening - Oil prices under pressure

A sustained decline in oil prices could impact capital spending plans in Alberta. So far it’s early days, and we’re not adjusting our forecast, but WTI prices have slipped below $60 on global recession fears and talk of further OPEC production hikes. We’re now tracking WTI around $65 (annual average), which doesn’t impact our already modest capex growth and production forecast. But risks are tilted to the downside and we await more company guidance before adjusting our forecast.

Close call - BofC rate pause was not a slam dunk

We were in the camp that the BofC could cut in April, given trade headwinds, but may elect for a ‘wait and see approach’. In the end, we leaned gently towards a cut.

Apparently it may have been a close call. The summary of the deliberations leading up to the April 16 interest rate announcement reveal that a minority of the Governing Council had the view that souring confidence and uncertainty justified a 25-basis point cut.

This is the key takeaway quote for me: “As long as medium- to long-term inflation expectations remained anchored, they had the flexibility to reduce the policy interest rate further to support growth.” In other words, if the inflation impact from tariffs is temporary and people don’t expect inflation to get out of line, the Bank feels they can cut. Our base case view is still that three more cuts are coming this year, bringing the policy rate to 2% by year end.

Delayed - U.S. jobs resilient…for now

The U.S. labour market remained resilient last month, adding 177,000 new jobs and the unemployment rate held at 4.2%. This was better than expected. However, keep in mind these are early days. Consumer confidence, a leading indicator, has plunged and we are of the view that job impacts will become more apparent in the coming months.

Interesting Fact: Understanding Canada’s weak innovation performance

A 2024 report by the Conference Board of Canada placed Canada 15th among 20 peer countries on innovation performance using 21 indicators.

Where does Canada score so low? Business R&D, patents and trademarks, and “fear of failure” are some categories. There are some areas where Canada does better, like higher education R&D, ICT use, and entrepreneurship. One of the themes is that Canada has the raw ingredients (early-stage funding, talented workforce, entrepreneurship), but does not always reap the rewards through the scaling of those efforts, including commercialization and product development.

A couple conclusions from the report:

“The country does relatively well at building its innovation capacity but fails to keep up with peers in innovation activity or see innovation-based economic results.”

“Canada is a risk-adverse innovation culture. Overcoming our country’s pervasive fear of failure and low levels of business, research and development (R&D) will allow us to tap into the nation’s thriving entrepreneurial spirit.”

Chart of the Week: Room to grow - R&D spending in Canada

One ingredient to better innovation and productivity outcomes is spending on R&D.

As our Chart of the Week shows, Canada’s R&D intensity is lower than the average across OECD countries, mainly reflecting lower spending in the business sector.

Canada ranks 20th among OECD countries in research and development intensity (R&D as a share of GDP). In 2023, Canadian R&D represented 1.8% of GDP compared to the OECD average of 2.7%. This weakness is driven by lower scores in the business sector.  Business spending on R&D was 1.1% of GDP in Canada vs. an OECD average of 2.0%.

Answer to the previous trivia question: Gross domestic product includes production within a country's geographic boundaries whereas gross national product includes production by a country's residents regardless of whether they are in the country or abroad.

Today’s trivia question: The Edmonton Oilers and Toronto Maple Leafs advanced to round 2 of the Stanley Cup playoffs last night, and the Winnipeg Jets could advance tomorrow. When was the last time a Canadian team won the Stanley Cup?