Smooth Sailing Ahead For the Global and Canadian Economy?

The consensus forecast of just about everybody – the IMF, the OECD, the Bank of Canada, the Canadian banks – is that Canada will share in a global recovery from the stagnation which followed the financial crisis of a decade ago. All of the major economies – the US, the EU, China, Japan – are growing; business investment is finally on the upswing from depressed levels; world trade is on the rise again; and fiscal austerity has more or less run its course. Central bankers, we are told, can be counted on to only gradually increase ultra low interest rates even as growth returns to near normal levels and employment recovers.

The world economy is forecast to grow about 3.7% in 2018, and Canada is forecast to grow at a respectable 2.5%, a bit below the rate in 2017.

This relatively optimistic outlook may well be true for next year. Many economic indicators are indeed very positive. But there are grounds to think that structural obstacles to a global recovery remain formidable. Indeed this view is registered by the financial markets in continued very low long term interest rates, which are based on an expectation of slow growth and low inflation over the next decade.

As widely noted, the recent upturn has been felt almost everywhere only very weakly in terms of wage growth, which is in turn by far the major determinant of household demand. Wages are generally lagging behind even weak labour productivity growth despite a significant fall in unemployment rates in the United States, Canada and even the European Union. In Canada, household spending growth has remained dependent upon increased debt rather than rising wages, even as the job market has seemingly tightened.

While the consensus forecast assumes that wages will gradually pick up, it is unclear what mechanism will reconnect wages to productivity growth in the absence of major structural changes such as the revival of a shrinking labour movement or hikes to minimum wages. The rise of insecure work seems to be limiting wage increases even at low levels of unemployment.

High and rising economic inequality is also a structural drag on growth. The continuing tilt of income growth to the most affluent means that a relatively high proportion of income gains will be saved rather than spent. The excess of financial savings over real investment is another reason why long term interest rates remain low.

High levels of household debt in many countries, again very much including Canada, also weigh against consumption and thus final demand growth. The pace of borrowing is likely to slow as interest rates creep up, making spending even more dependent upon wage growth.

Again as widely noted, following a very slow recovery, business investment remains sub par despite expectations of growth, and a large share of buoyant corporate profits is still being hoarded as cash or paid out to shareholders rather than re-invested. Part of the reason seems to be that growth has become more tilted towards the “new” high tech/digital economy where costly physical capital requirements are low compared to the “old”economy where expansion was based on major investments in new machinery and equipment rather than in intangible and relatively cheap intellectual and human capital.

Productivity growth remains low. For all of the talk of the emergence of a highly dynamic digital economy and the threat to jobs from artificial intelligence and the robots, growth in output per hour has been generally low, not least in the United States, and even more so in Canada. Pessimists point to the still small weight of the digital economy in the overall economy, which tends to low productivity growth due to the increasing weight of labour intensive services which cannot easily be automated.

The lack of global economic co-ordination also undermines the potential for sustained growth. The basic economic strategy of most countries, certainly including Canada, is to increase global market share through higher business investment combined with a competitive cost structure. Global competition and labour cost arbitrage by global corporations weighs against wage and income growth, fettering the growth of the overall global market. This structural problem may be exacerbated by openly protectionist trade policies if Trump prevails against liberal trade deals such as NAFTA and the WTO. Part of the solution is to co-ordinate expansionary fiscal policies and also to promote labour rights and standards across the global economy.

Added to the structural barriers to growth is the potential for systemic financial problems to once again undermine stability. A decade long run of very low interest rates has inflated numerous asset bubbles. Many countries, including Canada, have highly inflated housing markets which are vulnerable to a correction which would have a big negative impact on household wealth and spending. Equity markets are widely considered to be significantly over-valued, as are high risk corporate securities, creating risks for the financial system should prices fall. Many corporations have taken on excessive debt to pay out dividends to shareholders.

In sum, there are reasons to believe that the prospects for a sustained recovery of the global economy are not quite as robust as the new consensus would have us believe.