Economy

Economic Underperformance, Excessive Indebtedness, and Our Constrained Future

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:

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

What Drives Organizations? Applying Maslow’s Hierarchy of Needs to Corporations

In 1943, Abraham Maslow published his theory on the hierarchy of needs. You have probably come across it at some point in your life. Maslow used the terms "physiological," "safety," "belonging and love," "social needs," and "self-actualization" to describe the linear ascension of human motivation. According to Maslow, human beings are motivated to satisfy basic physiological needs such as food and water before they can progress to the next level of needs for safety, belonging, social acceptance, and self actualization. The further removed the individual is from simply obtaining the necessities of life, the less anxiety and tension is present as they seek to fulfill higher functions of personal growth. The pursuit of these functions is critical to the advancement of innovation as the individual is liberated to focus on the needs of others once their own necessities have been fulfilled.

The arc of Maslow’s theory closely aligns with the needs of corporations.  From a legal perspective, American corporations have been granted many of the same rights as individuals under the 14th amendment of the Constitution (See 1886 Santa Clara County v. Southern Pacific Rail Road). Over the past 130 years, corporations have evolved into legally distinct beings that enjoy many rights normally reserved for individuals such as the right to own property, enter into contracts, or pursue legal action. If corporations possess many of the same legal rights that individuals do, it stands to reason that corporations also share a hierarchy of motivations that begin with their basic need of survival.      

The International Monetary Fund is forecasting that the U.S. and Canadian economies will shrink by 8.0% and 8.4% this year because of COVID-19 related shutdown. As these effects hit corporate balance sheets, many executives have been forced to take extraordinary measures to keep their businesses solvent. corporate leaders are shifting their focus to satisfy the company’s basic ‘physiological’ needs for cash flow, liquidity, and debt coverage at the expense of higher corporate aspirations. The abrupt departure of these aspirations is particularly problematic when viewed in the context of environmental stewardship. As Maslow’s work highlights, the greatest advancements in corporate innovation are likely to occur beyond the base levels of sustenance. As corporations mortgage future development to sustain existing operations, critical ESG commitments, research, and technologies are less likely to come to fruition.

According to Bloomberg, climate change-related talk on S&P500 earnings calls fell from 33% in Q1 to just 17% in Q2 as Companies re-tooled their corporate strategies to focus on the fiscal necessities of survival. This is strong evidence that higher corporate functions are a luxury of choice – ones that are only possible if the basic corporate needs of survival are met. Therefore, stakeholders should celebrate Companies that remain steadfast in their commitment to environment, social, and governance standards in the face of a global pandemic. This praise is warranted because corporate ESG commitments confirms the importance of these factors to the survival of their business. These corporate leaders do not view ESG as a luxury of choice or a higher corporate function, but rather as a fundamental cornerstone to the success of their business.

As noted by Bloomberg, discussions regarding the acceleration of the climate crisis dropped by 50% on average across every industry in the S&P 500 earnings call transcripts from Q1 to Q2 2020. The largest pull back was seen by Technology Companies (53%), Financial Services (69%), and Energy Companies (58%). Energy Companies touted their energy transition goals earlier this year, but unsurprisingly this rhetoric has dwindled and has been replaced with urgent discussions regarding production cuts, liquidity, and plummeting demand. What may be surprising are the industries that have managed to keep ESG commitments front-of-mind during coronavirus-dominated earnings calls. As noted by Bloomberg, “Sustainability talk in the utility sector did decline in the first quarter, but only by 31%. The drop at industrial companies was just 10%”.

Earnings call transcripts are a way for management to communicate corporate priorities directly to shareholders.  While a pull back of long-term initiatives is inevitable as Companies focus on the short-term realities of survival, the degree of pull back could signal the level of commitment of Companies towards environmental stewardship in the long-term. The next time you are looking through the earnings call transcripts of Companies you have invested in make a point to quickly scan through previous transcripts prior to the pandemic to see which Companies are still including language outlining their ESG ambitious and what resources they will be dedicating to achieve those objectives.


Author

Michael Hebert, Viewpoint Research Team

Report: Alberta CEO Survey on Shutdown Impacts and Future Recovery

What does the road to recovery look like for Albertan businesses?

In collaboration with the Business Council of Alberta, we surveyed 61 CEOs to find out the impacts of COVID-19 on business, and what barriers and challenges lie ahead.

HERE'S A FEW HIGHLIGHTS

1 in 4 companies are unsure if they will make it through the pandemic until a vaccine is developed.

61% have engaged in layoffs, and 18% do not expect to refill these positions.

34%  anticipate needing continued or additional government support to mitigate downsides like stimulating demand, providing clarity on health and safety regulations, and maintaining liquidity.

To read the full results, download the report below.


Author

Viewpoint Research Team in collaboration with Business Council of Alberta

Massive Retailers Are Failing, Could They Have Been Saved?

The sudden wave of retail bankruptcies this year have been startling for shoppers and analysts alike. Whether they’re electing to pursue online-only retail strategies or shutting up shop completely, the “retail apocalypse” may have finally descended upon us. With Sears announcing its Chapter 11 bankruptcy to restructure, President Trump has come out publicly claiming that Sears “has been dying for years” due to mismanagement (which is ironic, as the US Secretary of Treasury, Steven Mnuchin, was also on Sears’ board of directors).

Sears was once the USA’s largest employer – the Walmart or Amazon of yesteryear. Toys R’ Us was once the Mecca for children’s toys. How are such high-profile retail outlets succumbing at such an alarming rate? Are shoppers simply moving online? Although ecommerce is an easy scapegoat for many retailers, it is likely not the main culprit. The evidence points to something deeper – systemic flaws within the culture of these retail monoliths that leave them no ability to adapt or re-invent their businesses, short-sighted management with little strategic planning, and huge debt levels from unmotivated private equity owners. “If you are going to run your business like most businesses, it is only reasonable to expect that you will end up like most businesses” – most likely out of business within five years.

This leaves us one question: where does the responsibly lie? Could the boards of these organizations have ultimately prevented these performance failures?

As we’ve seen, in their current state, it is too easy for boards of directors to overlook deep-rooted performance issues. This point is something Mac Van Wielingen has drawn on multiple times in his work – that the board needs to take a more active, vigilant approach to guiding the performance of their companies, escaping the gravitational pull that leads to“most directors [playing] a role akin to spectators…versus real players in the game, sharing in the responsibilities for outcomes.”


Author

Viewpoint Research Team