With last week’s federal deficit announcement, it is now more important than ever that we acknowledge our current realities with detail and clarity. We otherwise will be unable to develop a believable and effective path forward in the post-COVID world. The problem is that our current realities are uncomfortably negative. Many of us just don’t want to see this or believe it. We were in a slow-moving crisis of competitiveness, investment, and productivity prior to the COVID lockdown. Now, we have both stagnant productivity and excessive levels of debt. This feels negative as most of us understandably want to feel positive and optimistic about our future. However, for optimism to be real it must be grounded in reality. It is only then we can develop a believable and inspiring vision, and the appropriate strategies to recover and rebuild our economy.
Prior to the COVID lockdown, the economic fundamentals in Canada were already grim:
Business investment was about 20% below peak levels of 2014. Even outside the resource extraction sector business investment was below 2014 levels.
Canada’s labour productivity has significantly lagged that of the US, our main customer and competitor. In 2019, Canada generated US$55.00 per hour of labour compared to US$76.50 in the United States.
Returns on equities in Canada (including dividends) have been horribly inferior to global and US returns. Over the past ten years, cumulative returns on global equities have been over 3x that of Canada’s, and returns on US equities have been almost 6x greater than in Canada.
As a Canadian, if you were fortunate enough to accumulate savings, the last thing you should have done is to invest in Canadian companies on Canadian stock exchanges.
We were in a state of investment, competitive, and economic underperformance before the pandemic-related collapse. “Going back to normal” or “the way things were” is going back to a set of conditions that were compromising the future for all Canadians.
And now, we have the added reality of excessive debt. The inevitable consequence is a loss of financial flexibility, less capacity to spend, and more financial risk in the event of an extended recession, additional intermittent lockdowns, or some other new, unforeseen crisis.
Although the financial position of our federal government was reasonable going into the COVID lockdown (debt to GDP ratio was 35%), this has all changed seemingly overnight.
With a $350 billion deficit, we are now adding about 15% to the debt to GDP ratio. Maybe this still doesn’t look too alarming, however, we are missing a large part of the picture if we ignore the provinces.
We have learned in crisis that the national government will be called upon to backstop the credit demands of all provinces, and to a certain extent, even corporate and household debt.
Ontario’s debt is now about $400 billion, Quebec $200 billion, and then there are the other provinces. The Western provinces, including Manitoba, are now close to approximately $150 billion. The Atlantic provinces represent another $50 billion in debt. If you’re keeping track, that’s $800 billion of provincial debt combined with now over $1 trillion of federal debt. Total “all in” government debt is now at least $1.8 trillion and heading towards $2.0 trillion which would be 100% of GDP – that represents over $50,000 for every man woman and child in Canada, or $200,000 for a household of four.
Analysts and economists tend to look at debt solely on the basis of decision-making authority and responsibility at the entity level, as this is where insolvency would occur. This is why most don’t aggregate debt. But aside from insolvency risk, the key problem with debt that’s often overlooked is how it constrains choice and optionality. The aggregation of choice and commitment drives our overall economy. Understanding our economic outlook requires accounting for the burden of debt across all decision-making entities.
The government debt described above is layered on top of consumer and corporate debt. Total consumer debt in Canada is at a record $2.3 trillion which includes $1.6 trillion of mortgages. Household debt to disposable income is now at a record high of 181%.
Corporate debt in Canada is also at record levels of about $2.4 trillion and based on the Bank of International Settlements, our corporate debt service ratio is among the highest in the world.
Total household, corporate, and government debt is about $7.0 trillion. This is 350% on a $2 trillion economy.
The one thing we know about debt is that if you can survive through a downturn, it will constrain choice; it will constrain the scope and flexibility of decision-making commitments. This will be the new reality for many decision makers across the entire economy.
You can reasonably expect that consumers and corporations will be spending less and repairing balance sheets, and governments at all levels will be forced to be more accountable and discerning in spending and borrowing. All of this will likely be a net drag on the economy for years.
Unfortunately, this is all happening at the same time that Canada’s GDP per capita and labour productivity have been lagging.
The issue of productivity must be emphasized. To quote Nobel Laureate economist, Paul Krugman:
“Productivity isn’t everything, but in the long run it is almost everything. A country’s ability to improve its standard of living over time depends almost entirely on its ability to raise output per worker.”
Canada is now in an era of both stagnating productivity, low competitiveness, and excessive levels of indebtedness. In the corporate investment world, we often describe this as a “strategic straightjacket” – with less choice and less freedom to move. All of this should encourage a reset in priorities towards fiscal constraint, incentivizing investment, and pursuing more business-friendly policies and strategies that will tilt towards increasing innovation, productivity, and prosperity.
Author
Mac Van Wielingen
