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Canada: Prepare for the Long-Term Growth Slowdown

15 Feb 06

by Wojciech Szadurski

The Canadian economy has grown at an average annual pace of 3.0% over the past three decades, with employment growth at about 1.9% and productivity growth of 1.1%. The inevitable slowing of population growth, however, suggests that Canada's potential GDP growth will cool towards 2% over the next two decades, even with an optimistic assumption about productivity growth. Although the case for a significant slowdown in economic growth is very solid, many in the business community appear to be expecting the 3% pace to be sustained over the long haul. For example, a recent survey of economists, business analysts, and pension fund managers by Watson Wyatt found that median expectations of long-term real GDP growth in Canada stands at 3.0%. Unless they wake up to the demographic reality, Global Insight thinks the Canadian business community may be in for a big disappointment.

Global Insight's population forecast is based on Statistics Canada's medium-case projection and assumes that the fertility rate will stabilize at current levels and the death rate will continue to decline. We also assume net immigration levels of 150,000–200,000, with immigration of 200,000–250,000 and emigration in the 50,000–100,000 range. These assumptions imply population growth of 0.6% per year over the next 25 years, falling to about 0.5% late in the period. This population projection translates into employment growth falling from 1.9% annually in the past 30 years to 0.4% in the next 25 years. This slowdown could be moderated, but not prevented, by increased immigration.

Can Productivity Save the Day? Global Insight assumes that productivity (i.e., employment per real GDP) will advance 1.7% per year over the long term. This pace would match the average productivity gains experienced in Canada during the 1990s and mark a rebound from the disappointing performance of recent years.

Can we do better and have sustained productivity growth of 2% or higher over the long term? Not likely. To be fair, all levels of governments profess to support productivity growth. The natural leaning of democratically elected governments, however, is to sometimes prevent the necessary economic adjustments or to intervene in market mechanisms in order to protect the status quo. The protection of the existing economic order often impedes the very mechanism that generates productivity growth—the constant drive to create new products, adjust production processes, form new business ventures, explore new markets, and take competition to ever higher levels. Unfortunately, while this mechanism moves the economy forward, it also destroys many existing businesses in a cycle that Schumpeter called "creative destruction."

What does "creative destruction" have to do with population change? A lot, because many older people tend to opt for stability rather than change, and change is the very essence of productivity growth. If our assumption of 1.7% annual productivity gains over the long term turns out to be correct, this would still represent a considerable achievement, given our demographic make-up. The key driver of this growth will be the need for Canadian businesses to make the best out of increasingly scarce human resources.

Implications for Business. An aging population creates obvious problems regarding the survival and prosperity of companies in the face of rising retirement by experienced managers and workers from the baby-boom generation. To their credit, many companies and governments have been preparing for this impact by promoting younger people within their workforce and improving the incentives to retire later. There has also been considerable recognition of the need for defined-benefit pension funds to return to an actuarially safe footing after the "tech wreck" of 2001, and very low bond yields have left many pension plans under-funded.

While the problems associated with an aging population have been addressed by companies and governments, there has been less recognition of the coming slowdown in employment and economic growth. For companies serving the domestic Canadian market, the implication is much slower sales growth over the long term. The industries that will be affected include retail; arts, entertainment, and recreation; residential construction; real estate; and education. Depending on what segment of the population forms their client base, however, some businesses will be affected less than others. Geriatric care and estate planning, for instance, can be expected to do fabulous business, in contrast to toy and children's apparel stores.

Businesses selling to foreign markets have a different set of challenges altogether. They will face the conundrum of continuing solid growth in foreign demand—averaging about 3% per year over the long term—contrasted with a tightening of domestic labour supplies. Many manufacturers will escape the domestic labour constraint by increasing imported inputs in their domestic production, sending some operations offshore, or becoming integrated into global supply chains. The number of business trips from Canada to China, India, and other attractive locales will most likely rise significantly.

The Canadian resource sector, on the other hand, must deal with yet a different set of problems. Unlike most manufacturers, they have a limited scope for transferring operations abroad. Oil has to be squeezed out of the sands in Alberta and wood has to be hewed in British Columbia or other provinces. Such businesses will face even greater pressure than manufacturers to raise labour productivity and attract workers from abroad. Prudent and prompt adjustments to immigration rules for skilled workers by the federal and provincial governments will be necessary for Canada's resource sector to fully realize its potential over the long term. The current problems with attracting enough workers to non-residential construction sites and mining operations in Alberta and British Columbia are only a foretaste of things to come.

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