Glen Hodgson is a senior fellow at the C.D. Howe Institute.
Like every nation, Canada has taken a series of policy decisions over decades that together form the country’s overarching economic framework. There are some great strengths in that framework, but also some flaws that make it hard to achieve our full economic potential. Let’s focus first on the strengths, which help form a solid foundation for the Canadian economy. One cornerstone is a flexible or market-determined exchange rate, which was adopted as Canadian policy in 1970. A flexible rate helps Canada absorb the shocks of the global business cycle and particularly adapt to gyrations in commodity prices.
It is hard to believe that we once had a global system of fixed exchange rates in the post-Second World War period, backed by the U.S. greenback and linked to gold, that was designed to avoid the competitive devaluations of the 1930s. The result, however, was macroeconomic policy being driven by a need to maintain this rigid currency system, not by domestic fundamentals such as maintaining output and employment growth or keeping inflation under control. Few would argue today for a return to such an old-fashioned, backward-looking fixed exchange rate system.
A second related cornerstone policy is the Bank of Canada’s 2-per-cent inflation target and policy band. Canada was one of the first countries to adopt an explicit target for low and stable inflation in the early 1990s. A low-inflation target has provided an anchor point for monetary policy and has stabilized inflation expectations in many settings, such as industrial relations and debt markets, allowing Canadians to enjoy the important benefits of price stability.
Next, we would highlight a commitment to free trade. Canada’s broad policy consensus in favour of free trade has become a source of economic strength – but it did not happen overnight. It started with multilateral efforts to reduce tariffs and other trade barriers after the Second World War. The consensus was enhanced by the bilateral free-trade agreement with the United States and the pivotal 1988 federal election, when Canadian voters chose free trade. Completion of the North American free-trade agreement (NAFTA) in 1994, a few subsequent small bilateral free-trade deals, and most recently the Comprehensive Economic and Trade Agreement (CETA) between Canada and the European Union and the Comprehensive and Progressive Agreement for Trans-Pacific Partnership (CPTPP) are all steps on a free-trade path. There is still ideological opposition to free trade in some quarters, but after many decades a broad Canadian consensus in its favour seems solid.
In all three cases, the policy in question was the responsibility of the federal government and its institutions. The Bank of Canada and colleagues at the Department of Finance assessed, developed and implemented new approaches to exchange-rate and monetary policy with little need for broader consultation or negotiation. Advancing free trade was much more open to public debate but was still largely federal policy until recently, when areas of provincial responsibility such as government procurement and labour mobility became part of modern trade deals.
Canada’s broad commitment to public education and human capital formation is another policy on the list of strengths. Our kindergarten-to-Grade 12 education system is recognized as among the best in the world, complemented by solid postsecondary institutions – although other countries are overtaking us on university completion and on producing advanced degrees, as well as on graduates from vocational programs. Education policy is largely the purview of provinces, supported in places by the federal government.
Unfortunately, it’s just as easy to compile a list of flawed policies that ultimately hold Canada back. At the top of the list are the many regulatory barriers to efficient Canadian markets. Despite repeated efforts to reduce internal trade barriers, there remain myriad and often subtle barriers to forming an integrated pan-Canadian market. Media coverage usually highlights restrictions to internal trade in a few popular goods, notably beer and wine; but the more important internal barriers relate to labour mobility and skills recognition, and to different regulatory standards across provinces for products and services, including financial markets.
The domestic regulatory approval process for major projects has clearly become a barrier to investment. The process focuses principally on an open consultations process – while not emphasizing high technical and environmental standards, risk management practices and action plans for reducing any risks. At the same time, there is only limited federal-provincial alignment on defining and implementing a pan-Canadian climate change and energy transition policy. Similarly, provincial approaches to managing environmental risks are often inadequate, too often leaving taxpayers on the hook for cleanup.
After working hard for two decades in most jurisdictions to balance budgets and get public debt burdens under control, we seem to be drifting away from those goals. Federal and most provincial debt loads are not excessively high, but the cost of financing the debt is rising and the next inevitable recession will ratchet up the debt load. Moreover, repeated fiscal deficits in a growing economy do little to boost growth further, and are wasting fiscal stimulus ammunition that should be held in reserve for recessions.
Canada’s tax system is a multilayered patchwork quilt built up over decades, often with the wrong kinds of incentives, such as with a built-in bias toward taxing work effort rather than consumption. The last serious consideration of the overall tax system was the Carter Commission more than 50 years ago. There is little taxation of what economists call negative externalities, and tax populism has meant changes to taxation that are not supported by good economic analysis. Redesigning the tax system should not be a popularity contest.
Over all, Canada’s overarching economic policy framework lacks internal consistency, with some great strengths and lots of weaknesses. Such a mixed bag of policies can’t be great for robust sustainable economic growth or wealth creation.