Financial Post Articles
(Ed. note) Lloyd C. Atkinson is chief investment strategist for Perigee Investment Counsel. He was formerly an executive vice-president and chief economist at Bank of Montreal. (Ed. note) Issue 1 of a 12 part series.
Anyone with even a cursory familiarity with Canadian markets knows that optimism about our economic prospects represents a near 180-degree change in sentiment.
In fact, it is probably not too far from the truth to suggest that Canada was regarded as a near-pariah among foreign investors as recently as five years ago -- and for good reasons:
- An external indebtedness position -- the equivalent at its peak in 1993 of almost 46% of GDP -- that was proportionately five times greater than the U.S., the world's largest debtor nation.
- A productivity growth record that was one of the worst in the industrialized world.
- Potential political and economic instability arising out of the possible separation of Quebec.
Under the circumstances, the risk premium demanded by investors was huge: although no single statistic can fully capture this premium, one measure does come close -- real interest rates.
Thus for example, whereas real interest rates (interest rates adjusted for inflation) exceeded comparable U.S. real rates of interest by only one-quarter to one-half of a percentage point over most of the post-Second World War era, in the later part of the '80s and early '90s, those real interest rate spreads soared to more than 300 basis points -- an outcome, of course, that by itself served to aggravate the already dreadful economic and debt/deficit records of performance that produced the higher real interest rate spread in the first place.
This unenviable record is being reversed; and therein lies much of the newly found optimism about Canada and its prospects.
Of paramount importance is the fact Canadian governments are finally dealing in decisive ways with our crippling debt/deficit problem. The change has been so dramatic that the International Monetary Fund, which for years had issued warnings about Canada's profligate ways, has come full circle, now crediting Canada with perhaps the most aggressive set of budget policies within the G7 countries today.
What has impressed the IMF and other Canada watchers is the huge progress made to date, notwithstanding an economy very much struggling to discover a solid recovery footing five years after the brutal recession of 1991-1992. Equally impressive is the fact that Canada's governments -- federal as well as provincial -- have stuck to their guns and continued to reduce their budget deficit gaps despite noisy and well-articulated opposition.
Just why our governments have uncharacteristically stuck to their budget-cutting initiatives is interesting to explore. Is it because, as some would have it, our politicians have become mean-spirited and uncaring? Perhaps. But a more accurate characterization in my view is that our politicians, reflecting the well documented concerns of the majority of Canadians -- to wit, that continued profligate budget policies promised greater economic pain down the road than quick, decisive budget initiatives now -- knew that the road to popularity and re-election lay in respecting those collective sentiments.
It is the changed attitudes of Canadians, not our politicians, that provide the greatest assurance that our governments will continue to stick to their guns. This change in sentiment and policy direction has been a major factor serving to boost foreign investor confidence in Canada.
And while it appears paradoxical, these debt reduction initiatives will contribute to further improvement in the economy and ultimately add significantly more to the resources devoted to social programs than would have been the case otherwise. What some will no doubt find difficult to swallow is that, if you took away these recent budget initiatives, Canada as a just and caring society would have been in peril!
A second confidence booster -- the abrupt slowdown in the growth of our external indebtedness -- has come as the direct result of the sharp drop in our current account deficit.
Canada's current account deficit is a measure of the extent to which we as a country borrow from foreign markets to finance expenditures that, in aggregate, exceed our national income; it is a measure of the addition to our external indebtedness.
In 1993, our current account deficit was almost $30 billion -- nearly 5% of our then gross domestic product; today it is close to 1% -- a ratio that, if sustained, would sharply reduce over time our external indebtedness as a percentage of GDP.
Obviously, weak domestic growth (up until the latter part of 1996) contributed to the current account improvement. In other words, weak domestic growth served to slow import growth.
But that is only one element. The real story has been the improvement in Canada's export performance, not only to the U.S., but also to Europe, Latin America and the Far East. Yes, relatively strong U.S. growth and a super-competitive C$ have been important contributors to the improvements in Canada's current account. But there has been one other development that promises sustained long- run continuing improvement: the huge rise in Canadian productivity growth that has resulted from intense restructuring.
Also important to the improved current account has been reduced interest rates, a factor that has, obviously, reduced the debt interest payments on Canadian debt held externally. Of course, sustained low interest rates -- the most probable outcome given the current budget policies of our governments and the low inflation policy stance of the Bank of Canada -- will be important to sustaining the improvement in our current account.
A third, and more profound, confidence-boosting development has been the restructuring taking place in the corporate sector and in our schools. The economy is adjusting to technological advances that are shifting the competitive balance across the globe.
Following almost two decades of near-zero productivity growth in Canadian manufacturing -- one of the only sectors for which reasonably accurate productivity measurements are possible -- the '90s to date have witnessed huge improvements, with compound annual gains exceeding 5%.
Canadian companies, following the lead set by those in the U.S., are aggressively restructuring in ways that have surprised -- and delighted -- Canada watchers. Moreover, this restructuring is in evidence across the economy: in manufacturing and non-manufacturing alike. And there is no end in sight: the rapid pace of technology advance is being met by a near-equal pace of innovation and accommodation, holding out the promise of continued strong productivity growth for years, if not decades.
Unfortunately, the nature and consequences of the corporate restructuring sweeping Canada, the U.S., and the globe generally, is not as well understood as it should be. The use of such terms as the `new economy,' `paradigm shift' and `re-engineering,' to describe the transformation of our economy has not helped much to advance this understanding.
To be blunt, we are in the midst of a revolution -- a technology-driven revolution -- whose effects are every bit as profound as those delivered by the Industrial Revolution itself.
Two aspects of the Industrial Revolution are worth recalling: first, the `front end' of that revolution was characterized by huge -- some would say monstrous -- economic and social upheaval and dislocation. People from agriculture poured into towns and cities in overwhelming numbers. One after another, the cottage industries that had been the mainstay of the non-agricultural economy folded because they could not even come close to matching the production efficiencies -- and prices -- delivered by new, giant factories.
But the painful upheaval wrought by the Industrial Revolution was not in vain. In fact -- and this is the second critical aspect -- economies that successfully accommodated themselves to the realities of the Industrial revolution experienced increases in living standards the likes of which were then unfathomable.
In my view, we are still in the early stages -- the `front end,' if you will -- of the technology revolution where, to all too many people, social and economic upheaval are the only visible realities. But let us not be blinded by those realities. Only now are we beginning to see the generalized benefits that can be delivered to those who learn how to accommodate themselves to the realities of this revolution. And I suspect that 20 to 30 years from now, someone will be writing about the astonishing improvements in living standards that resulted from accommodation to the realities of the technology revolution.
This leads us back to productivity growth and the fact that there can be no generalized improvement in living standards without it. Rising output for each hour of work is the only way to realize rising real incomes per hour of work. And if we succeed in realizing productivity gains of 3% a year -- matching what we produced during the 1960s -- we could also realize, using the `simple rule of 72', a doubling of living standards every 24 years, or about once every generation.
And it is only in an environment of rising productivity -- and living standards -- that we can hope to successfully meet the needs and aspirations of the aging and those in need of the training and education essential to accommodate themselves to the requirements of a restructuring economy.
So what are the conditions required to ensure sustained increases in productivity? And is strong productivity growth consistent with a much lower unemployment rate and strong real income gains for workers?
Continued strong growth in business fixed investment in plant and equipment is critical to sustained productivity growth. This is investment that `embodies' the technological advances that lie at the heart of realizable productivity gains. Obviously, strong growth in the countries to which we export and in domestic demand are important elements too.
But other factors are of critical importance as well. Low real interest rates -- largely the consequence of continued progress in lowering government debt as a percentage of GDP -- is one. Another is a low and stable rate of inflation -- a direct consequence of Bank of Canada policy.
As of this writing, all of the elements noted above are strong positives.
The connection between rising productivity, reduced unemployment and higher real worker incomes is a bit more complicated -- but the story is no less optimistic.
First, there is no mystery why the unemployment rate rose so sharply during the severe 1991-1992 recession, the steepest drop in economic activity since the Great Depression of the '30s.
When the recovery began in late 1992, it proceeded along a distinctly dual track. Exports rose sharply because of strong growth in the U.S., a super-competitive C$, and competitiveness-enhancing corporate restructuring. At the same time, however, the domestic economy was stagnant .
The anemic domestic recovery, until very recently, was the direct consequence of unusually weak employment growth, which in turn was the consequence of persistently high real rates of interest, government cutbacks, tax increases and corporate restructuring.
Yes, government cutbacks, tax increases and corporate restructuring have caused notoriously weak employment growth and a sustained high rate of unemployment. And that has meant weak growth in real after-tax incomes and real consumer spending. But while the employment picture so far in the '90s has been very unsatisfactory, not much attention has been paid to what has been one of the most remarkable transformations of the Canadian labor market in this century.
There is not much to be enthusiastic about in the aggregate employment statistics. Since 1990, total employment in Canada has grown by only about 511,000 -- by only about 85,000 a year on average. This is a dismal performance compared with any other seven-year stretch of our post-Second World War history.
But dig into the numbers and a very important story unfolds. Look, for example, at the number of new jobs created for those with university degrees -- more than 589,000, an increase of about 31% since 1990. Similarly, we've created more than 813,000 net new jobs for those with post-secondary certificates -- but less than university degrees.
It's clear where we are going: in an economy that generated only 511,000 net new jobs since 1990, those with post-secondary and university degrees generated about 1.4 million net new jobs combined. Simple subtraction will tell you that those with only a high school diploma, or less, have suffered huge job losses since 1990.
The message is loud and clear: education and skills are essential elements of success in the transforming Canadian economy. And the popular notion that most of the new jobs are in menial, low-paying service occupations is simply false. Most in service, yes; most in low paying, no.
This is a terribly important message for it focuses attention on those aspects of our labor market that need direct and immediate attention: the skills and education of existing workers, both employed and unemployed; and our system of primary and secondary education.
There is one final piece to Canada's labor market story: In recent months, we have witnessed strong employment gains in several key areas including those directly related to an evident expansion underway in the domestic side of the Canadian economy. This renewed growth owes nothing to government hirings; it rather has to do with prior reductions in real interest rates and improved business prospects generally. To borrow from Ross Perot in a distinctly different time and context: `The great sucking sound you hear' is the sound of growing, healthy Canadian businesses attracting to their employ those with the requisite education and skill -- worker attributes that are, with few exceptions, teachable.
So strong will the `sucking pressures' be that, by the end of 1998, we should be looking at an unemployment rate near 7%.
I draw several conclusions from these developments :
- The importance of appropriate skills and education has never been clearer.
- The urgency that should attach to skills enhancement and education of today's workers, and tomorrow's, is pressing. Tomorrow's business pages papers will be dominated by tales of companies unable to find qualified employees while the unqualified languish.
In assessing these conclusions, let us never lose sight of what is taking place in today's economy: We have been witness to one of the most remarkable reformations of our economy imaginable. Canada's businesses are increasingly being recognized as amongst the most competitive in the world; productivity, like profit, is no longer regarded generally an ugly word, but as a precondition to rising standards of living and renewed employment growth. And no longer do we Canadians accept rising government debt-to-GDP and rising external indebtedness as acceptable policy options. For all these reasons, we should feel encouraged.
But there is one other development that, to this point, has only been touched on lightly and that is monetary policy.
In my view, the second-most important structural change that has taken place in the post-Second World War era -- the first being the technology revolution -- is (and this will surprise some) the attitudes of today's central banks with respect to inflation.
Let me put this bluntly: No matter what causes any initial inflationary impulse -- rising commodity prices, an energy price shock (such as occurred in the 1970s), labor market pressures -- there can be no sustained additional general inflationary pressures unless the monetary authorities provide the requisite accommodating finance.
Moreover, to the extent that the monetary authorities are prepared to act with vigor at the first sign of inflation (which appears to be the attitude of today's G7 central bankers) -- to the extent, that is, that today's central bankers will act to remain `ahead of the curve' -- then there is no reason why inflation will rear its ugly head, except temporarily.
The corollary of this proposition is equally important: If the monetary authorities are vigilant and successful in containing any renewed inflationary pressures, then they will have no excuse not to provide finance sufficient to accommodate non-inflationary growth.
In my view, this is the environment we find ourselves in today: The zero tolerance for inflation that is the working premise of monetary policy everywhere in the G7 today is the best guarantee that inflation will not return and that the monetary authorities will provide finance sufficient to accommodate non-inflationary growth.
This is a truly remarkable change in philosophy and approach to monetary policy. And, to a large extent, we have former Bank of Canada Governor John Crow to thank for this change of attitude in Canada. As the influential president of the Bank for International Settlements -- the central banks' central bank -- he's promoting this zero-tolerance strategy elsewhere in the g7. Gordon Thiessen, co-architect of this strategy with Crow, carries on the tradition here at home.
Let's take stock of the remarkable story unfolding in Canada:
- We have gone from an unsustainable pace of external indebtedness -- as seen by our current account deficits -- to a sustainable pace.
- Our corporate sector has adopted as its strategy a degree of accommodation to the promising technology revolution that has advanced us to a standard of international competitiveness well above our previous level.
- And, we have established ourselves as one of the leading countries in the continuing fight against renewed inflation.
And, is it any wonder that I expect the Canadian stock market to outperform the U.S. for the next two years at least. This will be all the likelier if global demand continues to strengthen, raising the demand for resources, which will drive up the value of resource stocks whose weight in the Canadian market is three times their weight in the S&P 500.
Yes, Canada's ship is arriving.
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