Protectionism and lack of investment are hobbling Canada’s economic potential, report argues

Canada’s economy isn’t focused enough on investment, a shortcoming that puts the country on a path to fall behind in competitiveness and experience a slow erosion of living standards, according to a new report from law firm Bennett Jones LLP.

The report, published June 12, concludes that more competition at home would stimulate stronger investment and position Canadian firms to “win” globally, crucial goals in a period of high interest rates, “sticky” inflation and increasing fragmentation in supply chains and trade.

“Protected markets and poor incentives for investment in Canada will do the opposite,” the report warns.

The authors say Canada should tackle improvements to “framework” policies in areas including competition, regulation and taxation, focusing on changes that would incentivize innovation and the investment and reinvestment of companies’ retained earnings.

At the same time, raising the share of GDP linked to investment should be accomplished through targeted measures that ensure Canada gains a foothold in emerging critical industries including digital and clean tech and technologies such as electric vehicles. Such a strategy would both accelerate productivity growth and position Canada to compete globally on the path to a clean economy, the report said.

“Poor investment in Canada not only deprives our economy of growth opportunities, it means that our firms lag their global peers in their capacity to conquer global markets, and that they may fail to take advantage of the vast possibilities permitted by our trade agreements with major economies,” it said.

The authors acknowledged there are challenges to the path they are promoting, calling tax reform “a perilous political exercise at the best of times.” But the report urged governments to consult and engage with businesses while being responsive to global forces and challenging vested interests and policies that hold back competition and breed complacency.

“Rules and tax structures need to be adapted to a world that is rapidly expanding the potential and applications of digitalization, where a rising share of economic value is generated by intangible assets,” the report said, adding that some initiatives are already underway and should be “pursued with vigor and a sense of urgency.” The list includes a review of competition policy, modernization of privacy and data management legislation and steps to accelerate digitalization in the financial services industry.

The report’s authors, members of the governmental affairs and public policy group at Bennett Jones, said raising the share of national income devoted to investment would reduce the share available for current consumption but it would provide a foundation for long-term prosperity.

While this shift is crucial for the future, the report acknowledged that Canada’s short-term priority must be to get back on path to non-inflationary growth.

“Hikes in the policy interest rates of central banks have helped to moderate demand and rates need to be high for longer. Inflation will not get back to target quickly,” the report said. “Consequently, global growth will be weak in 2023, recover some momentum later in 2024 and only by 2025 be at roughly potential for the medium term, with low inflation.”

Even after inflation is back near the target of two per cent, the report said there is reason to expect that interest rates will remain higher than they were before the COVID pandemic and that growth potential will be lower. The authors note that while U.S. and European authorities acted quickly in March 2023 to resolve failing banks, financial stress remains given record levels of public and private debt. Moreover, intensification of the war in Ukraine, or rising tension over Taiwan, could push up commodity prices, depress confidence and unsettle capital markets.

The authors noted that the IMF’s global growth projection for the next five years is the lowest since 1990. Globally, there are risks of recession and “disorderly adjustment,” while inflation may prove to be “sticky” and stretch out the return to noninflationary growth beyond 2025.

The report suggested Canada’s interest rates appear to be near a peak at 4.75 per cent and would likely come back down gradually in 2024 and 2025. This could translate to real GDP growth of around one per cent, rising to an annualized average growth rate of 2.5 per cent by the end of 2025. But uncertainty remains.

“There are risks to this scenario,” the report cautions. “If global developments cause new stress, or if inflation is stickier than expected, there could be a recession, but more likely a prolonged period of low growth and adjustment.”

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