Rail protests expose potholes on Canada's road to economic transition – The Globe and Mail

As the rail blockades arising from the Coastal GasLink protests drag on, there’s no doubt that they will have an impact on the economy. Economists spent this week whittling down their first-quarter growth forecasts, citing severe snarls in supply shipments have hampered business activity and exports. But the economy will bounce back once the blockades are inevitably cleared, and this will appear as only a minor blip in the economic record.

What will linger is the lasting image, both within Canada and without, that we are a country that, five years after the collapse of its oil market, is wrestling harder than ever with how to transition to an economy more driven by its knowledge than its geography. The economy is still struggling to establish a clear path amid the decline of oil and the rise of the climate debate. Oil and gas will be a source of jobs and activity for many years to come, but there’s a large hole to fill in investment in the next phase of growth, and filling it will be an ongoing challenge of the new decade.

In the five years since prices for oil and other commodities crashed – something that looks increasingly to be a long-term decline, especially for oil – the Canadian economy has drifted away from energy investment, in part due to weakened returns for investors and in part due to the federal government’s climate agenda. Statistics Canada estimates that capital spending in oil and gas extraction last year was less than half of what it was at its peak in 2014 – a loss of nearly $40-billion in annual investment.

That story has largely overshadowed the signs that investment in non-resource sectors has begun to fill the void. Capital spending in the real-estate services, rental and leasing sector is up nearly 60 per cent since 2012. Investment in education infrastructure is up 33 per cent. Investment in telecommunications technology has more than doubled. Spending on public transit and rail transportation has also doubled.

In fact, even with the dramatic decline in capital investment in the oil and gas sector since the oil crash of 2014-2015, Canada’s total capital spending is up 31 per cent in the past decade.

On the surface, then, it does look like investment has been quite successfully rotating from oil-economy resources to new-economy services and the knowledge economy – a success story amid the resources tumult.

But consider those sources of investment growth, and what they indicate. Statscan’s gross domestic product (GDP) data show that the country’s capital spending growth in the past several years has not come from business, but rather from government (particularly Ottawa’s dramatically increased infrastructure program) and, to a lesser extent, residential real estate. Non-residential business gross fixed capital formation –indicative of what the private sector is investing – has recovered little after its oil-shock slump, and remains nearly 20 per cent below its pre-oil-shock peak.

“There really isn’t anything else picking up the slack” for the loss of oil and gas investment, said Bill Robson, president and CEO of the C.D. Howe Institute, a Toronto-based economic think tank. Mr. Robson noted that in past cycles, slowdowns in the oil and gas sector were typically accompanied by pick-ups in manufacturing investment, as the benefits of cheaper energy costs made that sector more attractive. But that traditional investment rotation has been largely absent this time around.

“It is striking that the adjustment has been as painful and incomplete as it has been. … There really just hasn’t been that kind of shift of [business] resources into other productive uses,” Mr. Robson said.

“It does speak to the idea that there’s something else going on that has prevented us from switching over.”

It hasn’t helped that all of this has come during an extended period of weak business investment globally, amid tepid growth, rising trade protectionism and geopolitical uncertainties. In Canada, the three-year drama surrounding the North American trade pact had a serious chilling effect on investment commitments, weighing particularly hard on the export-intensive manufacturing sector.

But Canada’s business investment problem may go deeper than that – a weakness that for years was masked by the lure of booming energy prices. In a study published by C.D. Howe last August, Mr. Robson reported that on a per-worker basis, Canadian business invests nearly 30 per cent less than the average among Organization for Economic Co-operation and Development (OECD) countries.

Critics say the boom of the oil and gas sector masked Canada’s competitive weaknesses in attracting investment in general, because the returns for investors were so glaringly apparent in the oil patch. With that advantage in the rear-view mirror, the country is going to need to rethink some things – in areas like regulatory red tape, corporate tax structure, innovation policy – to attract new kinds of investors.

“You have to compete to get those investment dollars,” said economist Paul Boothe, deputy director of the Trillium Network for Advanced Manufacturing, an Ontario-based non-profit. “What governments need to turn their minds to is, what’s the next big thing?”

Patterns in foreign direct investing into Canada may already provide some direction to that. While foreign direct investment (FDI) in Canada’s oil and gas industry has been essentially flat since the oil crash, total FDI excluding the oil and gas extraction sector grew a healthy 14 per cent from 2015 to 2018. Sectors that have seen strong FDI growth include chemicals manufacturing, transportation equipment, communication technology and key service industries such as scientific and technical services and management consulting.

That suggests that foreign investors are already seeking out ways to tap into the parts of the economy that have been supplanting natural resources as sources of growth – something that predates the oil shock. Employment in resource sectors has been slowly declining as an overall share of Canada’s labour markets for decades. With the exception of the oil boom, resources’ share of GDP has also generally trended lower, as the services sector long ago supplanted goods as the largest part of the Canadian economy. Bank of Canada Governor Stephen Poloz pointed out in a recent public address that Canada’s fastest-growing source of both exports and employment today is the information technology (IT) services sector; it now makes up about 5 per cent of GDP – about the same as oil and gas extraction.

There is one critical area of the economy in which natural resources remain a dominant component: They account for nearly 40 per cent of Canada’s goods exports, on a value basis.

“The need for what it is that we are endowed with is determined by the stage of development of countries around the world. … We have to remind ourselves that 50 per cent of the world is still growing at a much faster pace than we developed economies are – and at that stage of development, they need a lot of resources,” said Peter Hall, chief economist at Export Development Canada, a federal export credit agency.

“It’s maybe not fashionable to talk about it in that way, but that’s exactly where we are at.”

While that suggests a continued role for resource extraction and exports even as the country’s knowledge-based economy continues its emergence, economist Mel Watkins worries that the country will continue to pursue policies focused on resource extraction at the expense of promoting investment elsewhere. It’s something he has been arguing about since he popularized the phrase “staples trap” to describe this Canadian phenomenon in 1963.

“A business class, a business culture, had been implanted that was satisfied with exporting resources as the leading sector of the economy,” Mr. Watkins said, arguing that the boom of the energy sector in the early part of this century re-entrenched this economic bias. “There was an insistence that resource export must be encouraged as the best way to create jobs.”

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