Mr Thiessen evaluates the performance of the Canadian economy at the end of the 20th century  (Central Bank Articles and Speeches, 2 Jun 1999)
Central bank: boc | Type: speech | Date: 1999-06-02

## Mr Thiessen evaluates the performance of the Canadian economy at the end of the 20t centuryAddress by the Governor of the Bank of Canada, Mr Gordon Thiessen, before the Can Club in London on 2 June 1999.As the curtain comes down on the twentieth century and we move on to the next mille it is difficult to resist the temptation to be both retrospective and prospective.Ask Canadians to think back and many will tell you that the economy and they, as indi have been through some difficult times.Those with longer memories, however, will recall the remarkably positive climate betw end

of the Second World War and the early 1970s.

Canada came out of the war wi relatively strong economy compared with the ravaged European countries.

Moreover, were sizable and sustained gains in productivity through the 1950s and 1960s.

These the revolution in agriculture and the forced modernization and expansion of Canadian during the war as well as the rapid changes in technology and industrial proce followed.All this led to a substantial rise in Canadian standards of living instead of depression that many had feared.

And despite the exodus of workers from agricultu overall unemployment rate remained low.

At the same time, rapid economic growth gene rising tax revenues that governments could spend on an increasingly wider social s without taxpayers feeling much of a pinch.Compared with this post-war prosperity, our economic performance over the subseq quarter century has been the source of some disappointment and concern.Various explanations have been advanced for this less-favourable record since t 1970s.

There are four trends in particular that I would highlight in this regard: hig the 1970s and 1980s; large and rising fiscal deficits from the mid-1970s to the mid slowdown in productivity growth; and a decline in the prices of primary commodities.Tonight, I propose to comment on these four trends and their effect on the economy past 25 years.

Much of the sense of economic disenchantment that Canadians have feeling in the 1990s has been related to the difficult process of reversing thes adjusting to them.

Fortunately, considerable progress has been made on several front there are grounds for optimism regarding Canada's economic future.

## The harmful effects of high inflationThe rate of inflation which, after getting through some of the post-war bottlenecks just over 2 per cent in the period to 1972, more than tripled over the next two decadThis

pickup in inflation was not a uniquely Canadian phenomenon.

In many count monetary policy had become too expansionary during the late 1960s.

This partly ref misconception among policy-makers that, by fine-tuning the economy and taking advantaa perceived trade-off between employment and inflation, overall economic well-being cou be improved.One of the initial consequences of this accumulating worldwide monetary stimulus was sharp rise in the prices of oil and other primary products in the early 1970s.

Countri Canada, which are major producers of such commodities, experienced a surge in income and wealth.

But they also faced strong demand pressures and rising inflation.

In Canada, the in inflation was especially dramatic, reaching 12 per cent in 1974.Once inflation had risen to those levels, it was very difficult to reverse.

With each year, expectations of ongoing high inflation became increasingly entrenched.High inflation exacts a heavy toll on an economy by making the future particularly uncer Long-term financing becomes less available and more costly as interest rates go up becaus inflation and the higher risk premiums that lenders demand as compensation for the increa uncertainty.

Inflation diverts resources away from productive investments into specula ventures in real estate and other financial assets.

And in its interaction with the ta high inflation encourages businesses to increase debt.

These are the very types of excess lead to, and indeed aggravate, the economic busts that inevitably follow.

During the 1970 1980s, Canadians had first-hand experience with such complications.

## The impact of persistent government deficits and rising debtHigh inflation was also partly responsible for the move towards larger government defici Canada that began in the mid-1970s.Initially, inflation tended to generate increased revenues for governments, and this enco additional

spending.

When the effects of inflation became more evident, however, publ pressure led to the indexation of the personal income tax system and the growth government revenues slowed.

Unfortunately, this was not offset by a tighter grip on spendFor the government sector as a whole in Canada, on a national accounts basis, total pro expenditures (not counting debt-servicing costs), rose from 37 per cent of gross dome product (GDP) in 1975 to a peak of 43 per cent in 1992 (a year of recession).

Over the period, the budget deficit more than tripled to 8 per cent of GDP.

And the ratio of outst net debt-to-GDP soared from less than 10 per cent to 60 per cent, and by the mid-1990s it climbed to 70 per cent.Increasingly, through the late 1980s and early 1990s, the growth in government spendi raised concerns about whether this represented the most efficient use of the econom resources.From a policy perspective, the greatest concern was that persistent large deficits were p Canada's debt-to-GDP ratio to unsustainable levels and driving up risk premiums in o interest rates.The economic costs of Canada's rising indebtedness became very clear after 1991, when ou inflation rate came down quickly, but medium- and longer-term interest rates were slow respond.

One important reason for that was the persistence of high risk premiums becausefears that governments might be tempted to reduce the debt burden through inflati effect, by printing more money.

Canada's vulnerability to such concerns became part evident during the Mexican currency crisis.High interest rates meant that we had to pay more of our income to foreign holder public and private sector debt.

This made us poorer as a nation.

And these hi discouraged investment which, to some extent, relates to the third 'disappointing' t past quarter century - the slowdown in productivity growth.

## The slowdown in productivity growthProductivity has been at the centre of many public discussions in Canada recently. reason, too, since productivity is critically important to growing incomes and risin of living over time.Unfortunately,

such discussions are complicated by the fact that there is more measure of productivity, and there often seems to be some difficulty in distinguishin the growth and the level of productivity.

Things become even more complicated as on into cross-country comparisons.After a strong showing from the end of the Second World War to the early 1970s productivity growth became lacklustre.

Output per worker slowed from an average r about 3 per cent in the 1950s and 1960s to 1 per cent in the 1980s and 1990s.Productivity growth also slowed in other industrial countries, including the Unit over this period.

Indeed, average gains in labour productivity in the Canadian business sectors have been roughly similar in the past 25 years.

This means that productivity levels in favour of the United States has not really widened; but ne narrowed.

Moreover, growth in U.S. productivity seems to have picked up strongly in year or so.I do not have a complete explanation for the productivity slowdown in Canada.

Bu prepared to assert that high inflation and the large fiscal deficits through most o years were not conducive to productivity growth.

They led to high interest ra considerable uncertainty about the future - both of which discourage the invest technology and new equipment that helps to advance productivity increases.

## Declining primary commodity pricesThe final factor on my list is the decline in the prices of the key primary commo Canada produces.Calculated from the early 1970s to the present, this decline amounts to some 45 per the international prices of these commodities in U.S. dollars are adjusted for the the general price level during this period.

A drop of that magnitude in the prices Canada's major exports is bound to have a significant effect on our standard of livinTo look at the past 25 years in isolation, however, tends to magnify the extent of and leaves one with an exaggerated sense of the associated economic consequences.because commodity prices jumped to historical peaks at the beginning of the period, response to the worldwide monetary stimulus that I mentioned, and remained generally hig for nearly a decade or so, before reversing.To put things in perspective, we need to focus on the longer-run behaviour of commodi prices.

For only then does it become clear that these prices were exceptionally high th the first decade of this 25-year period, and that a good part of the subsequent down movement represented a return to more 'normal' levels.

Indeed, between the late 1960s a the late 1980s, the level of inflation-adjusted commodity prices showed little change oveWe should also keep in mind that part of the decline in commodity prices has reflected discoveries of raw materials, more efficient ways of extraction, and reduced production c Otherwise, we would have seen a much larger reduction in the importance of commodities, and in the profits and share prices of Canadian resource industries.When one allows for some of these factors, the downward movement in commodity prices in the past 25 years is not as dramatic as it appears at first.

But I can certainly apprecia sharp drop in these prices in 1997-98, associated with the Asian financial crisis, has especially strong impact on many Canadians' sense of well-being.

Adjusted for inflati commodity prices hit a new post-war low during this period and led to a substant depreciation of our currency.

## What does the future hold?So

far, I have argued that high inflation, large government deficits, slower produc growth, and lower commodity prices have tended to complicate Canada's economic situation over the past 25 years.

But as I said at the beginning, much of the greater sense of di and concern that Canadians have felt in the 1990s has to do with the after-effects of the medicine we have had to take to turn our economic performance around.

The success we have had so far in this regard bodes well for our future.Canada's inflation rate has come down dramatically, averaging less than 2 per cent si 1992.

And there are now agreed targets between the Bank of Canada and the Government of Canada to keep inflation low and stable in the future.

More importantly, Canadians have c to expect continued low inflation and to build that expectation into their plans.The federal government and most provincial governments now have balanced budgets or are running surpluses.

The total government debt-to-GDP ratio, which peaked at 70 per cent 1996, has since fallen to 63 per cent.

With present prudent fiscal policies, it should co decline steadily.Future gains in productivity are difficult to predict.

Certainly, our improved inflat fiscal situation, together with the low interest rates that they have made possible, pro best climate for fostering productivity that we have had in a long time.

Moreover, Cana businesses have undergone major restructuring during the 1990s in response to increasin competitive world markets.

Business investment has been rising smartly recently and mo firms have been adopting new production technologies.It is also interesting to note that, after eight years of economic expansion, produc in the United States has picked up, rather than falling off as usually happens at the cycle.

Tight labour markets seem to have encouraged a record level of investmen country and more efficient use of technology than before.

While the pickup in C investment in machinery and equipment has lagged somewhat behind that in the Un States, new technology is not the exclusive preserve of our U.S. neighbours.

So I ho Canada, too, we will see a similar payoff from the adoption of new technology comparable improvement in productivity.As for commodity prices, there has already been some turnaround this year, but a recovery requires a strengthening world economy - in particular, a turnaround in J the rest of Asia.The other point to note in this connection is that the relative importance of commod Canadian economy has declined.

The share of primary products in total Canadian expor fallen from about 60 per cent in the 1970s and 1980s to about half as much presently.I should also add that our flexible exchange rate system has been playing the ro should in helping us adjust to lower commodity prices.

The decline in the value Canadian dollar in 1997-98 was mainly a response to the impact of the Asian cr commodity prices.

A weaker currency has helped to cushion the negative effect o resource sector.

But, more importantly, it has helped to stimulate demand for other exports and import substitutes, particularly of manufactured goods.

In turn, this is a shift in production from commodities towards other tradable goods.While I believe that this shift is exactly right for the Canadian economy, I do not some recent suggestions that we should somehow force the pace of the movement ou primary products and into the so-called more modern, knowledge-based industrie commodity prices do not recover from their current low levels and profits are squee result, this will happen naturally.

But for now, primary products are still an impo of Canada's wealth and high standard of living, and they are likely to remain so forTo conclude, the past 25 years have not been easy.

And they have been less prosperous than many Canadians had come to expect, based on the experience of the 1950s and 1960But, as we stand on the threshold of the next century, we can take comfort f remarkable progress we have made recently in strengthening the foundations of our ec This gives me reason to be positive about our capacity to improve our economic perfo and to meet tomorrow's challenges with confidence.