Is Everything in Canada’s Economy Broken? No, but There’s a Lot That Needs Fixing

As Canadians prepare to spend a long weekend by the water or watching fireworks, it’s a good time to take stock of the state of the economy and where it’s going. As our latest Economic and Financial Outlook (EFO) External link. highlighted, the prospects for growth in Canada have improved, as they have broadly around the globe. We now expect real GDP to increase faster in the Great White North than in any other advanced economy this year and next, save for the US (graph 1). Some of this respectable growth performance we anticipate can be chalked up to relief coming for Canadian borrowers, as Canada was also the first G7 country whose central bank cut interest rates. And this early easing in rates was supported by prices that have advanced more slowly here than in most peer countries—also a good news story. All told, better growth and lower inflation than in many other advanced economies, coupled with relatively early rate cuts, tell a comparatively positive tale.

But these high-level economic indicators are cold comfort for a lot of households still feeling the pressure of elevated borrowing costs and high prices. Canada’s housing market remains highly unaffordable, and our research suggests that isn’t likely to change anytime soon External link.. Rents are sky high too, as an influx of non-permanent residents (NPRs) compete for a limited stock of rental housing (graph 2). High and rising shelter costs have helped keep the overall level of prices high, even as the pace of inflation has slowed. And with a wave of mortgage renewals at much higher rates just around the corner External link., many households are feeling more squeezed than ever before. This is particularly true for the lowest income Canadians, whose savings rates have fallen into negative territory, as we will discuss in detail in a forthcoming note. 

Businesses are experiencing challenges too. The surge in insolvencies this year is particularly stark (graph 3). The sectors with the highest insolvency rates, such as hospitality and retail, were also those we flagged as being most vulnerable in the run-up to the Canada Emergency Business Account (CEBA) loan repayment deadline in January External link.. These were the same sectors experiencing the sharpest labour shortages coming out of the pandemic as well, and who turned to NPRs to fill much of that gap. But if the federal government follows through on its plan to limit the number of NPRs in the country, this source of relatively inexpensive labour will become scarcer. And with few Canadians waiting on the sidelines to fill those positions External link., labour costs are likely to rise External link. and margins to be squeezed.

Less temporary labour could be an impetus for renewed investment in productivity-enhancing innovation. But poor productivity is a perennial problem in Canada External link. that long precedes the recent boom in newcomers. The same is true for real GDP per capita External link., which first stagnated following the drop in oil prices in 2014. Businesses need to adopt new technologies such as artificial intelligence External link. to help boost efficiency. This is particularly true for small businesses External link., which struggle to find the time, staff and financing to invest in the latest innovations. And despite being Canada’s productivity leader, oil and gas extraction is unlikely to return to its pre‑2014 dominance of the Canadian economy against the backdrop of a global energy transition.

That leaves a potential role for policy in supporting Canadian business investment. A decade ago, many economists would have championed governments playing a more activist role in supporting innovation. Indeed, we found External link. that the public sector has historically played an outsized role in innovation leaders like the US, Israel and South Korea. However, picking winners and scattering spending around has proven ineffective in spurring innovation and productivity growth in Canada. Instead, more supply-side policies like lower taxes on investment and entrepreneurship (in contrast to the recent increase in the capital gains inclusion rate External link.), along with reduced regulations, could be more effective. Focusing on incentives that reward businesses for growing as opposed to staying small may also be helpful. Fortunately, as we’ve highlighted time External link. and again External link., Canada is in one of the strongest fiscal positions of any advanced economy, both at the federal and total government levels. Without jeopardizing our fiscal standing, it may be time to try something new to boost investment, because what Canada’s doing now isn’t working. And when something’s broken, it’s best to fix it.