Trudeau’s economic fix: Easy to promise, hard to deliver

Don’t expect a sudden rebound in the economy now that Trudeau is in charge. The global downturn will make things worse before they get better.
Liberal leader Justin Trudeau gestures as he arrives on stage during a campaign rally in Edmonton, Alberta, October 18, 2015. Canadians will go to the polls in a federal election on October 19. (Chris Wattie/Reuters)
Liberal leader Justin Trudeau gestures as he arrives on stage during a campaign rally in Edmonton, Alberta, October 18, 2015. Canadians will go to the polls in a federal election on October 19. (Chris Wattie/Reuters)
Chris Wattie/Reuters

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In the waning days of a long campaign, Stephen Harper said only he could “protect” Canada’s vulnerable economy, supposedly the most important question on the ballot. But Canadians instead handed over the keys to a fresh-faced Justin Trudeau, who must now deliver on a difficult promise to get a $2-trillion economy back on track at a time when the world is conspiring against him.

Trudeau’s majority government will take shape at a time when Canada’s growth has been hammered by a global rout in oil and other commodity prices. Exports are crumbling as China economies slows and U.S. companies are being hurt by the high U.S. dollar. At the same time, there are mounting concerns about the growing indebtedness of Canadian households and soaring real estate prices. “I think the global economy is worse than we were discussing a few months ago,” says Mike Moffatt, an assistant professor at Western University’s Ivey Business School, who acted as one of Trudeau’s economic advisers. “And that means the Canadian economy is worse, too.”

The centrepiece of Trudeau’s plan to dig Canada out of the mire consists of three consecutive years of deficit spending totalling up to $10 billion per year. If he follows through on his promises, some of that borrowed money will help pay for a doubling in federal spending on infrastructure projects to $125 billion over the next decade—everything from public transit to “social infrastructure” like affordable housing for seniors. The idea, supported by former Bank of Canada governor David Dodge, is to take advantage of record-low interest rates and a manageable federal debt-to-GDP ratio to borrow and invest in projects that promise to boost Canada’s long-term growth potential, while, hopefully, also creating a near-term economic tailwind. Douglas Porter, the chief economist at BMO Capital Markets, says the Liberals’ plan would amount to a not-insignificant half a percentage point boost in GDP. However he cautioned it won’t have an impact on headline growth for over a year.

Equally important is what a few years of budgetary spending would do for the Bank of Canada, which has been using monetary stimulus to promote growth even as Harper’s austerity measures created a drag. Economists say a more stimulative fiscal policy will take pressure off the Bank. “It could have an implication for the bank’s policy by further reducing the chance of cutting rates again,” Porter says. “It could even increase the chance they raise rates a bit earlier.”

Moffatt sees another distinct advantage to the Trudeau deficit plan, particularly now that he’s been elected: breathing room. “If they find out the economy is a lot worse than they thought, they can spend more because they never said they’re going to balance the budget,” he says, adding that voters are unlikely to put up much of a fuss if the government spends $12 billion per year instead of a promised $10 billion.

Aside from budgetary decisions, the other pressing economic file facing Trudeau is the Trans-Pacific Partnership. The Harper government negotiated the final stages of the 12-nation trade pact behind closed doors during the election campaign. If ratified, it promises to give Canadian businesses increased access to markets in Asia, particularly Japan, while opening the doors to more tariff-free imports in Canada that could result in cheaper prices for consumers. During the campaign, Trudeau steered clear of criticizing the pact but made it clear he would need to see the full text of the deal before passing final judgment. In reality, he’s likely to wait to see whether the U.S. ratifies the agreement, which has already drawn the opposition of Democratic front-runner Hillary Clinton. “If it does get approved in the U.S., I think it will be very difficult for Canada to turn it aside,” says Porter.

Less clear, but potentially more far-reaching, is what Trudeau’s government will do on the climate change file and the energy sector. He’s promised to meet with provincial premiers within 90 days of the UN Climate Change Conference, to be held in Paris at the end of November, “to develop a carbon pricing policy” that would set national emissions targets. But he’s also promised to allow provinces to design their own emissions reductions policies, noting that some, like B.C., have already introduced a carbon tax. While some have criticized Trudeau for failing to play more of a leadership role on the issue, Werner Antweiler, an associate professor at the University of British Columbia’s Sauder School of Business, says the Liberal party’s vagueness was a deliberate political calculation. “He knew he would get clobbered if he proposed another carbon tax like [former Liberal leader] Stéphane Dion did,”Antweiler says. “That said, I think he’s left a door open to revise his position.”

Yet, for all the coming changes in Ottawa after a decade of Conservative rule, Canadians shouldn’t expect a sudden improvement in the country’s fortunes. As Moffatt notes, Trudeau will find himself facing a bleaker global outlook than Harper did when the election was called back in August—a period that itself could hardly be described as euphoric. At the time, voters were already grappling with the possibility the Canadian economy, battered by the rout in oil prices, had fallen into a recession for the second time in six years. The dollar, meanwhile, had plummeted to US75 cents, its lowest level in more than a decade, while China’s stock market had just endured an epic crash that wiped out more than US$3.3 trillion, raising concerns about the health of the world’s second-biggest economy.

There were glimmers of improvement—in June and July the economy eked out modest gains that Harper gripped like a life preserver. But then, with little warning, the storm clouds over the global economy worsened again. Beginning in late August, investors abruptly lost faith in Beijing’s ability to manage its stock market crisis, sending global markets into tailspin. On Sept. 17, the U.S. Fed delayed its planned interest rate hike because of ongoing market concerns about China and the pressure falling commodity prices placed on the economies of resource-producing countries, including Canada’s. “Overall, I think the sense is the [Canadian] economy returned to some growth after a tough first half,” says BMO’s Porter. “But interestingly, it’s been a very different story globally. We’ve had equity markets go through a full-blown correction, and there are mounting concerns about how emerging markets are doing. That even seems to have taken a bit of steam out of the U.S. economy, which looked to be the best game in town.”

Looking ahead, the economic challenges facing Canada’s next government remain daunting. While China appears to have sidestepped an uncontrolled crash—third-quarter GDP growth came in at 6.9 per cent, just below Beijing’s target—the continued slowdown will have ramifications for Canada in the form of further weakness in oil and commodity prices for years to come. That’s a problem given that oil is now trading around US$45 a barrel, well below the roughly US$80 a barrel “break-even” cost for most oil sands projects. Already the sector has yanked about $60 billion worth of planned investments and cut tens of thousands of jobs, sending Alberta spiralling into a recession.

At the same time, there are concerns exporters in other parts of the country—namely Ontario and Quebec—won’t be able to pick up the slack despite a cheap loonie that makes their products more competitive when sold overseas. David Watt, the chief economist for HSBC Bank Canada, said in a recent note that Canada’s export sector is structurally weak, and that Canada has lost market share south of the border, making it harder to benefit from a pick-up in U.S. growth. “Until Canada overcomes its productivity and competitiveness hurdles, it will continue to feature cyclical behaviours”—meaning boom and bust— “similar to those of emerging market economies,” Watt wrote. “The oil downturn has revealed Canada’s broader growth challenges, which include rising debt-to-GDP levels, borrowing-fuelled consumption, lacklustre productivity performance, and a poor record in R&D.” Add it all up and it’s easy to see why the IMF predicts economic growth in Canada of just one per cent this year and 1.7 per cent in 2015.

If Trudeau is successful at implementing his promised deficit spending, he may be able to boost next year’s GDP growth closer to two per cent. Beyond that, he will likely find himself thwarted by the same forces that his predecessor faced: a sluggish global economy that stubbornly refuses to co-operate.