Paul Jenkins: Beyond recovery - sustaining economic growth
Remarks by Mr Paul Jenkins, Senior Deputy Governor of the Bank of Canada, to the
Economic Club of Canada, Toronto, 29 March 2010.
* * *
Good afternoon. It is a pleasure to be here.
John Maynard Keynes said the objective of "analysis is ... to provide ourselves with an
organized and orderly method of thinking out particular problems .... This is the nature of
economic thinking."1
This is very much the tradition of the Economic Club of Canada, which offers an important
forum for analysis and discussion of economic issues, certainly those we have had to
address since the onset of the global financial crisis. The Bank of Canada has offered its
analysis and perspective on these issues, especially global and domestic developments, the
policy actions needed to address the situation, and how best to position the Canadian
economy to the benefit of all Canadians over the medium-to-longer term.
In the wake of the global financial crisis and the "Great Recession", economic recovery is
under way, supported by exceptional monetary and fiscal stimulus. In many countries,
however, large output gaps remain and, given the need to repair the balance sheets of
households and financial institutions in these countries, the return to full resource utilization
will be protracted.
What I'd like to discuss today is the economic environment beyond recovery. I'll set the stage
by discussing, in general terms, the kind of global economic landscape we're likely to see
five to ten years ahead. Then I'll look at several important areas of public policy that will help
to shape that outcome and promote sustained economic growth. Finally, I'll focus on some of
the challenges and opportunities that a significantly different global economic landscape will
pose for Canadian business.
A changing global economic landscape
The global economic landscape will change considerably over the coming decade. To get a
sense of what it may look like, it's useful to consider both the developments that are required
for global economic growth to be sustained, and the likely impact of the powerful trends that
have been shaping, and will continue to shape, the world economy.
It is clear that, as a nation, Americans need to save more and rebuild household sector
wealth. For too long, the U.S. economy has been consuming more than it has been
producing. This means that, in the future, more U.S. economic growth must come from net
exports - a combination of higher exports and lower imports. Consumer demand will be a
relatively less important source of growth. China, on the other hand, will need to rely more on
domestic demand as the engine of growth. This rotation of global demand is needed as part
of the solution to the global (current account) imbalances that were a significant part of the
genesis of the financial crisis. Without this rotation of demand, resources will not be fully
utilized, and global economic growth will be neither as strong, nor as sustained, as it could
be.
In addition to these requirements, powerful forces are changing the economic landscape.
One is the difference in the growth rates of potential output (the rate of growth that can be
sustained over time without inflationary or deflationary consequences) that we are likely to
see over the next five to ten years. For the major industrial economies, that rate of growth of
potential output is estimated to be between 2 and 2 1/2 per cent. For the major
emergingmarket economies, the rate is estimated at between 5 and 8 per cent.2 Much of this
difference can be attributed to the fact that emerging-market economies have "catching up"
to do - by combining labour and more intensive use of capital in production - and to the fact
that they have a large and growing pool of labour to draw upon.
This rotation of demand and the differing rates of growth of potential output will have
significant implications for trading patterns and investment flows. While it's not possible to be
precise, and it depends on whether one uses market or purchasing-power-parity exchange
rates, major emerging-market economies will likely account for over 55 per cent of global
output by 2020, compared with about 45 per cent today.3
To be sure, there are many variables and uncertainties at play that will affect how the global
economic landscape will look ten years out. Some refer to these uncertainties as the "known
unknowns". But, one thing seems clear - the economic landscape ten years from now will be
significantly different from that of today.
An important task for public policy will be to shape that outcome - remove some of the
unknowns - for the benefit of everyone. On the heels of the global financial crisis and the
Great Recession, one element of that task is to restore trust in markets, particularly financial
markets. Trust is needed if financial markets are to price assets correctly and allocate capital
efficiently. More broadly, a price-based system remains the most efficient way to allocate
resources and generate growth that is led by the private sector. The reality is that for
sustained growth to take hold, private sector demand must become the primary source of
that growth. Public policy has an important role to play in supporting such an outcome by
establishing coherent medium-term policy frameworks that will guide expectations and
reduce uncertainty.
The role of public policy
I'd like to discuss three areas of public policy that will contribute to this goal. Let me start with
financial sector
reform.
A stable, efficient financial system is a cornerstone of a healthy and dynamic economy.
Policy-makers are currently at an important stage in multilateral discussions about
fundamental reform of the financial sector. The core of the G-20 reform proposals is aimed
at:

increasing the amount and quality of bank capital;

introducing complementary leverage caps;

increasing levels of liquidity;

mitigating procyclicality;

improving over-the-counter derivatives markets; and
 developing internationally consistent contingency and resolution plans for
systemically important institutions.
This is important work. The objective is to make the financial sector more resilient through
better and more effective regulation - not more burdensome regulation.
fiscal
The second area of public policy receiving attention is consolidation. While the
recession made it necessary for governments to step in and provide considerable economic
stimulus to offset a decline in private spending, sustained growth requires that this stimulus
be removed as private spending gains strength. Another way to think about this is that the
savings being generated in economies need to be funnelled back for use by the private
sector. The IMF estimates that "government debt for advanced G-20 countries [will] reach
118 per cent of GDP on average by 2014", compared with a pre-crisis level of about 78 per
cent.4 For 2010, the combined fiscal deficits of these countries is estimated at nearly 9 per
cent of GDP.
One important factor will be clear guidance from governments about the means and the
timing of fiscal consolidation. Given the size of the deficits, tough choices will need to be
made. Clear communication in this regard can help to manage market expectations and
reduce uncertainty.
The third area of public policy concerns the openness of markets. One lesson not to be
drawn from the global financial crisis is to impose controls on the movement of goods,
services, capital, and labour. Protectionism and controls are detrimental to everyone. As a
trading nation, we understand that. The focus must be on opening markets and removing
barriers to trade and capital flows so that all can participate in the changing global landscape.
This focus is equally important for our internal markets. A renewed push is needed to remove
barriers to internal trade in Canada. The goal is to have the most efficient allocation of
resources possible to enable us to capitalize on the opportunities of a new global economic
order.
Let me conclude this section with a few additional thoughts on what this changing global
landscape means for the major emerging-market countries. These countries have achieved
considerable successes in recent years. They responded in a forceful and timely manner to
the financial crisis, and they have been the strongest-growing regions in the global economy.
Building on these successes, these countries should have the confidence to allow market
parameters to play a more active role in their economies. Doing so would include greater
exchange rate flexibility to allow relative price signals to contribute to rebalancing and
sustaining global economic growth, thus strengthening the global trading and international
monetary systems. Indeed, another thrust of the G-20 process is mutual recognition of the
need for a collaborative effort with regard to policy actions on those fronts I have just been
discussing - financial, fiscal, openness of markets, and exchange rate - to the benefit of all.
Let me turn now to the private sector in Canada, and discuss some of the implications of the
changing economic landscape for business here at home.
Implications for Canadian business
What will the new global landscape mean for Canadian business? I said earlier that, going
forward, private sector demand must replace public support as the engine that drives
sustained economic growth. This transition implies change for business, but, most
importantly, beyond the transition, the new international economic order will bring many
opportunities. To take full advantage of them, business will need an appetite for change.
Significant restructuring is already occurring in many sectors. The forest products sector
continues to go through a difficult adjustment. In Ontario, we are all well aware of the
challenges facing the automotive sector. More generally, Canada's export sector has had to
adapt to a strong Canadian dollar, intense competition from emerging-market economies,
and the shift in the relative weight in global demand from advanced economies to
emergingmarket economies. Herein lies one of the most important issues facing Canadian business -
how best to deal with the opportunities and challenges posed by the dynamic
emergingmarket economies.
The strong demand in these countries for materials, finished products, and services -
ranging from legal to financial to educational services - presents tremendous opportunities
for Canadian business. And these possibilities offer additional opportunities - including those
of developing innovative products and services, working with new partners, and optimizing
the mix of global and domestic activities. In other words, the opportunities will be substantial,
and they come on a two-way street, with benefits for everyone. But taking advantage of them
will require a willingness to actively engage with these new markets. Make no mistake. To
recognize the potential growth of these markets is to recognize the rising purchasing power
of these countries and their citizens.
Encouragingly, many Canadian companies are acting now and are entering markets in
emerging economies with strategic, long-term initiatives. A common thread of these
initiatives is that they are taking advantage of Canada's comparative advantages, which
include a stable financial system, reliable infrastructure, plentiful natural resources, and an
educated, multilingual workforce.
Of course, with this opportunity comes a broad set of challenges - challenges that apply to
all facets of Canadian business. These include acquiring, developing, and retaining the right
people, applying technology to enhance research, operational work, and the management of
value chains, addressing environmental issues, and recognizing and dealing with increased
global interdependencies.
At the risk of oversimplifying, a critical element in dealing with both these opportunities and
challenges is investment in modern, productivity-enhancing equipment and structures. Our
track record in this regard has not been impressive, even adjusting for the cyclical factors
and uncertainties of the past two and a half years. Compared with previous decades,
productivity growth has weakened substantially in the past ten years. This poor performance
appears to be at least partly attributable to insufficient "capital deepening" - that is, the
amount of capital with which workers are equipped. Another part of the problem appears to
be that capital investment is not always well integrated into the workplace.5
Let me expand on this last point. I'm referring here to what we call multifactor productivity.
You have a computer on your desk, and the question is: Are you making full use of what that
technology can do for you? Are you integrating that investment to full benefit in terms of
organizational practices and producing end products? We ask ourselves these questions at
the Bank of Canada, whether they relate to investments in our analytic computing capability
or the handling of bank notes. They are the right questions to ask.
With our trading partners, including the United States, continuing to invest and make strong
gains in productivity growth, it is all the more imperative that firms in Canada make concerted
efforts to boost productivity. And from one perspective, they are well equipped to do so.
Corporate balance sheets in Canada are healthy. Profitability is good, with the ratio of profits
to GDP back to its long-term average of 10 per cent. Leverage - i.e., debt-to-equity - ratios
are low and liquidity levels are high. Corporate tax rates have declined. Absolute borrowing
costs are low. And while the non-price terms for borrowing have been a restraining factor,
our Senior Loan Officer Survey indicates that these terms are beginning to ease as the
recovery takes hold. From this perspective, then, there should be little holding corporations
back from modernizing their capital stock.
But there's an additional perspective, and that is the extent to which firms can access funds
for making productivity-enhancing investments. The role of the financial sector is to channel
savings to the real economy. Given the importance of small and medium-sized enterprises in
Canada, it is critical that this sector invest in productivity-enhancing improvements.
Compared with similar-sized firms in the United States, these Canadian firms rely more on
individuals for financing and less on financial institutions.6 This, to me, suggests a market
opportunity for our financial institutions. As well, additional sources of higher-risk capital are
needed for Canada to be successful in modernizing the economy's productive capacity
through innovation and new technology. For our part, the Bank of Canada, together with
financial market participants, is helping by working to make our financial system more robust
through continuously open commercial paper, interbank, and repo markets, and through
stronger infrastructure arrangements.7 These initiatives provide greater efficiency in the
allocation of financial capital, which benefits all sectors of the economy.
Allow me to conclude.
Conclusion
The world is emerging from the most serious economic dislocation since the Great
Depression. While the global economy is on a steadier footing, the pace of change will not
slow down. Indeed, five to ten years from now, the global economic landscape will be greatly
altered.
Public policy has recently played an important role in helping the economy to heal. It must
also play an important role in ensuring that the conditions are in place for sustained and
balanced growth over the coming decade. That includes public policies that focus on creating
an attractive and certain economic environment, an environment that promotes investment
and innovation. Progress is being made internationally to meet the major policy challenges of
our time - but work must continue until the job is done. Domestically, our frameworks for
macroeconomic and regulatory policy served Canadians very well through the financial crisis,
and have positioned us to move forward. But we have more work to do here at home - to
further open internal markets and to strengthen our ability to address systemic risks to the
financial sector that can arise from the collective actions of institutions and market
participants.
For Canadian business, a rapidly changing economic landscape presents new possibilities
and hurdles - chief among them, seizing the opportunities presented by emerging-market
economies, and stepping up to the challenge of improving our productivity record. This
should be one of the next waves of economic progress in Canada.
The Bank of Canada will do its part by contributing to sustained, solid economic performance
by providing Canadians with confidence in the future value of money. An environment of
stable prices lowers uncertainty, reduces the cost of capital, and enables Canadians to plan
for the future with greater confidence.
I'd be happy now to respond to comments or questions.