Proceedings of the Standing Senate Committee on
Banking, Trade and Commerce
Issue 11 - Evidence - Meeting of April 20, 2005
OTTAWA, Wednesday, April 20, 2005
The Standing Senate Committee on Banking, Trade and Commerce met this day at 4:10 p.m. to examine and report upon the present state of the domestic and international financial system.
Senator Jerahmiel S. Grafstein (Chairman) in the Chair.
[English]
The Chairman: I welcome the Canadian audience to one of the most important hearings of the Standing Senate Committee on Banking, Trade and Commerce. Twice a year, for some years now, for those who are not aware, we have had a meeting with the Governor and senior officials of the Bank of Canada. We are delighted to welcome David Dodge and Senior Deputy Governor Paul Jenkins here today. Not only are you being viewed from coast to coast to coast, governor, but you are being viewed, for the first time, via our auspices, on the World Wide Web. People far and wide, from the central banks of Asia to the central banks of South America, will be watching and listening to every word with great anticipation and delight. We thank you for attending again. We are anxious to hear what you have to say, and I know honourable senators are anxious to question you on their concerns.
Mr. David Dodge, Governor, Bank of Canada: Thank you very much, Mr. Chairman. It is a great pleasure to be here for the first time in your new quarters — new leadership, new quarters.
[Translation]
As always, we appreciate the opportunity to meet with you twice a year, following the release of our Monetary Policy Report. These meetings help us keep senators and all Canadians informed about the Bank's views on the economy and about the goal of monetary policy and the actions we take to achieve it.
Last Thursday, we released our April Monetary Policy Report. In the report, we said that the global economy has been unfolding largely as expected, and the outlook for the Canadian economy is essentially unchanged from that in January's Monetary Policy Report update.
The Canadian economy continues to adjust to global economic developments. These developments include the realignment of currencies in response to global imbalances, the higher prices of both energy and non-energy commodities, and growing competition from emerging-market economies.
[English]
In Canada, we are seeing more evidence of sectoral adjustments to these global developments. Many Canadian commodity-producing sectors are expanding. However, firms in some other sectors that are exposed to international trade are facing pressure from the appreciation of the Canadian dollar and from foreign competition. On balance, net exports have been a drag on the economy but, with robust domestic demand, some sectors, such as retail, wholesale, housing, for example, have been growing strongly.
Overall, the bank expects Canada's economy to grow by 2.5 per cent in 2005 and 3.25 per cent in 2006, with growth this year and next coming primarily from strengthened domestic demand. To continue to support aggregate demand, we decided to leave the target for the overnight rate unchanged at 2.5 per cent on April 12.
The bank continues to judge that the economy is operating slightly below its production capacity, and we expect that it will move back to full capacity in the second half of 2006. Core inflation is projected to return to 2 per cent around the end of 2006. Based on the scenario implied by oil price futures, total CPI inflation is expected to remain slightly above 2 per cent this year and to move slightly below 2 per cent in the second half of the next. In line with this outlook for growth and inflation, a reduction of monetary stimulus will be required over time.
This outlook is subject to both upside and downside risks and to uncertainties. The risks include the pace of expansion in Asia and the prices of oil and non-energy commodities. A further risk relates to the resolution of global current account imbalances. Should these persist, the risk of a disorderly correction will grow over time. Most of the uncertainties with respect to the Canadian economy relate to how the economy is adjusting to the relative price changes associated with major global developments. Monetary policy continues to facilitate this adjustment process by aiming to keep inflation at the 2 per cent target and the economy operating near its production capacity.
Honourable senators, we will be happy now to take your questions.
The Chairman: Governor, thank you for being concise. I urge my colleagues to be as concise as you. They have questions and comments, and I would hope that in order for us to all have an opportunity to question, senators will show restraint.
Senator Angus: Gentlemen, it is always nice to have you with us. On this occasion, it is immediately after your appearance yesterday in what we call the other place. I have looked at the transcript of your comments there. As well, I could not help but observe your presence on the front page of some of our major newspapers this morning. I am sure you will hear some questions about the issue of bank mergers, which seemed to catch the national interest. I will not address my first question on that subject, but I am sure others will.
I would like to focus on what you have referred to in general terms, that is, ``global imbalance'' being nowadays a major factor affecting the well-being or otherwise of the Canadian economy. You mentioned it when you appeared here in November. You certainly mentioned it yesterday in the other place. I notice in your opening statement you have referred to it in at least two paragraphs. I understand it to be the offshoot of a circumstance where, say in the United States, consumers are spending aggressively and not saving, thereby creating an imbalance, and at the same time in other countries they are producing at a great rate and are saving. There is also a dual form, where some currencies are pegged or are floating, like the Canadian dollar, and other places, such as China, have a fixed exchange rate tied to the U.S. dollar. You have talked about the risks that arise for Canada in particular from the imbalances that result and the difficulty of adjusting to them.
This is complicated stuff for us and for all Canadians, and I would like you to try to describe this problem for us and for the listening audience so that we get a better sense of what you are trying to tell us and what we should be looking out for. I think you sounded quite a strident warning here on two or three occasions, so I am anxious to get a clear understanding of what you are talking about.
Mr. Dodge: Thank you, senator. You have touched on one of the key issues. Indeed, I spent last weekend down in Washington at the IMF and with the G7, and this was one of the key items on the agenda.
First, we are talking about the situation in the United States, where savings fall far short of domestic investment, and hence the United States is importing savings from abroad; whereas abroad, principally but not exclusively in Asia, they have exactly the opposite situation. There is nothing wrong with that in principle. Indeed, we have had periods in our history when we have had very large current account deficits. There is nothing wrong with the current account deficit, or the surplus, as we now have. The real worry is how these evolve and whether the mechanisms are there to allow them to correct themselves over time. Market mechanisms will normally make the correction.
We see it all the time here in Canada. One region of the country will have excess savings and another will have a deficiency of savings. Capital moves, and people move, and over time, the balance is restored. Normal market mechanisms within a country work quite well to restore it, albeit the adjustment is sometimes difficult. The worry on the international stage is that these mechanisms are not being allowed to fully work.
Obviously, labour is not nearly as mobile internationally as it is nationally. That mechanism does not exist, and so you need other mechanisms, such as trade flows and capital flows, to make the adjustment. Normally, one would expect over time that a country with a heavy investment would import capital from abroad, i.e. net deficiency of saving, and vice versa in a country without a terribly high investment. Over time, through movements in interest rates, relative prices and, internationally, exchange rates, the market would move to correct those imbalances. While there might be a few bumps along the way, things should work out.
The real worry at the moment is that policies are impeding the normal operation of the market to correct those imbalances. Policies in the United States are geared to high consumption and high maintenance of shortage of savings. Policies in Europe are not particularly flexible, and hence we do not have strong consumption growth there. Precisely the same thing is true of Japan. In China and other Asian countries, while there is very high investment, we have rather weak consumption and an exchange rate mechanism that is not being allowed to facilitate those corrections. That could continue for a while but not forever. It will stop, but the question is, how will it stop? We worry that without the full panoply of market mechanisms to make this correction, because nations are not adopting the appropriate micro- economic policies or following the appropriate exchange rate policies, it could come as a major shock to the world, with extremely slow growth and rising unemployment; and Canada has to worry about rising protectionism.
That is a start to the answer to your question, senator. We will continue to try to provide any further clarification.
Senator Angus: You said that rising protectionism is the most obvious example. Could you put it in terms such that if X were to happen then it would have the effect of Y on the Canadian economy?
Mr. Dodge: You cannot do it quite that simply, but to derive a sense of the spectre that we worry about, just think back to 1930 when one or two countries put up trade barriers and the retaliation by other countries began. That natural temptation must be fought. It becomes even more tempting when there is a sense that some countries may not be playing by the rules. Currently, we are observing that on Capitol Hill, Washington.
Senator Angus: Is that in terms of protectionism?
Mr. Dodge: That is right.
Senator Angus: Does that have a direct effect on Canada? Obviously, we have some trade issues that are fairly public.
Mr. Paul Jenkins, Senior Deputy Governor, Bank of Canada: Certainly, as Governor Dodge indicated, these things have a cascading effect. When you see protectionist measures in one jurisdiction, they affect trade more generally; and that is one risk we are concerned about. The governor also touched on the fact that this is a complex set of issues, in that it is not about exchange rates only. One of the concerns is the policy action in the United States to raise their levels of savings, the flip side of which is reduced consumption. Without offsetting measures in other countries to raise their levels of consumption, you begin to see an effect on the global economy in terms of overall rates of growth.
This is a multidimensional issue, and that is why we continue to talk about it at international meetings such as those of last weekend. We consider it not only important for Canada but also for the global economy.
Senator Angus: We will have to continually revisit this subject.
[Translation]
Senator Massicotte: I will try to summarize the comments you made yesterday. According to the newspapers, you said that bank mergers allow increased efficiency, and consequently, this could increase productivity and make services more competitive. This would be beneficial to consumers. I think you also made a comment about Canadian banks, about the fact that the higher level of capital might be more competitive nationally and internationally. At the same time, and this explains the concern of many people, you suggested that cooperatives or caisses populaires might fill the gap and overcome the fear we all have regarding small and medium-sized businesses and people who live in the country.
I would like more information about the studies done by the Bank of Canada to support these three hypotheses. Some people fear and say that even if there are fewer banks and even if there is a potential for increased efficiency, perhaps there will not be enough competition because there are already so few players. As a result, consumers might not necessarily see any benefits. A number of experts say that our Canadian banks have not been a success in the United States. It is true that for several of them, this has been a failure, in fact, two or three banks are now returning to Canada. There were a few comments made about cooperatives meeting certain needs, but have any in-depth studies been done that could alleviate our concerns about these three hypotheses?
Mr. Dodge: Last December, I made a speech in Toronto about the efficiency of the financial markets in Canada. I spoke about the efficiency of financial institutions and the merger of financial markets themselves.
In this speech I highlighted the issue of efficiency in the research we have done at the bank. If institutions and markets are efficient, this will be better for the growth rate in Canada. There must be a good allocation of savings following investments in order to make things as profitable as possible. That is the role of the money markets and the institutions. It is extremely important to stress at all times the efficiency of these institutions and markets.
What we have seen in research done outside Canada and in our research on development in Canada, is that there were benefits as a result of consolidation in the banking sector — either the consolidation of the banks themselves or the consolidation of various institutions such as insurance and bank investment.
I am talking about economic research. There is evidence that consolidation has delivered benefits to consumers and to issuers. The general direction of these findings is virtually the same throughout the world, but the studies vary very widely as to the estimated gains as a result of these consolidations. However, the direction is quite clear. That is simply what our research shows.
What we have seen as well for a long time, since the Porter commission in 1964, is that in Canada and later throughout the world, financial institutions became more efficient as a result of the elimination of constraints limiting the activities of institutions and the operation of markets.
So the direction is clear. After a certain length of time, these institutions and the markets become more efficient. However, this is not a simple matter, and regulating financial institutions is quite complex.
[English]
The Chairman: Governor, I do not mean to be the schoolteacher here, but we do have a long list of senators who wish to ask you questions. Perhaps you might abbreviate your responses.
[Translation]
Senator Massicotte: The role of the main bank is to keep the value of the dollar stable. Like a number of other banks throughout the world, we focused a great deal on inflation. Some central banks, particularly in Europe, are talking increasingly about ``asset pricing'' in other words, not just inflation in the prices paid by consumers, but also in assets, such as homes.
I know the bank made a statement two or three weeks ago that it may study its measurement of inflation so as to discuss this with the government and set the inflation target. Will the Bank of Canada be changing its target or its way of measuring inflation to include asset pricing, or will this always remain in the consumer price index?
Mr. Dodge: That is a rather complex question. I will try to give a brief answer, but I could come back to this, because it is a very interesting topic.
We are carrying out some research at the moment, because in 2006, we have to renew our agreement with the government for the next few years. We said that we must do some investigating. Could we gain something by watching the rate at which assets appreciate or depreciate? Is there on-going information in asset pricing that could help us attenuate or even add time to our objective of returning to 2 per cent inflation in 18 to 24 months?
That is an interesting subject and we could perhaps come back to it if there are other questions along these lines.
Mr. Jenkins: Briefly, there is a slight difference in the information contained in ``asset prices'' that the central bank can use in implementing monetary policy. This is very different from the idea of including ``asset prices'' in our monetary policy targets.
[English]
The Chairman: I neglected to introduce another newly appointed senator, from the sovereign province of Alberta, Senator McCoy.
Welcome, Senator McCoy. When I have examined the debt of provinces, I have noticed Alberta is the only province that has really been fiscally sound and safe, in the sense that they have not only paid off their debt but are running a surplus. We will be looking for your wisdom on how to conduct our business.
Senator Harb: Thank you, Mr. Dodge, for your excellent presentation.
I have a question about a speech that you gave to the National Association for Business Economics in the U.S. I have seen a quote attributed to you that I found quite interesting. When talking about the Bank of Canada's approach, you stressed that inflation targeting has been seen as a means to an end, not an end in itself. You said that inflation targeting is the best way to achieve high, sustainable growth of output and employment.
It seems to me that to a large extent, that has been successful for quite a few years. I want to compare that with what they do in the U.S., where they use a parallel-track approach through which they do not explicitly pursue inflation targeting, but rather, focus on long-term price stability that, in their view, will maximize growth.
Is there room for us in Canada to also have a parallel approach whereby we would keep an eye on inflation while also focusing on economic growth through full employment, for example, or other means?
Mr. Dodge: As I pointed out in that speech, the objective of the central bank here, as laid down in our law, is very similar to the approach of the U.S. Federal Reserve; that is, so far as is possible within the scope of monetary action, to promote employment and growth, et cetera. We have that in our law.
The question is how to go about doing it. We have found over time, and we are not unique in this, that the best contribution a central bank can make to high and sustainable employment and output, strong growth over time and stability is to promote confidence in the future value of money — price stability, or as we express it, to keep inflation at a 2 per cent target.
We have come to the conclusion that this is the best way to get there and that when Canadians have confidence that we will do this it actually promotes growth. That is why we have adopted the inflation-targeting approach. As you know, there is a big debate in the United States on whether they should adopt our approach.
Senator Harb: My second question deals with deciding whether you will increase the rates. You normally look at a variety of factors here in Canada; you look at habits, input-output and other factors. To what extent do you also look at outside factors such as what happens in the U.S. or Europe and the emergence of China? How do you value those events with respect to your decision? Is there a rating system for that?
Mr. Jenkins: That is a very good question. The framework that we have built around our explicit inflation target has a focus, first and foremost, on how we view aggregate demand in the Canadian economy. That is the total demand within Canada and export demand of consumers, businesses and governments. We are constantly looking at all sources of information that would give us an indication of how that aggregate demand is unfolding. In a sense, we take all of what you have just said into account, and we do that through a number of different channels.
We look at indicators of what is happening in China or the United States, and we work through the implications of that for aggregate demand. The way in which we see those trends in the Canadian economy for aggregate demand influences our decision making. The overall objective is to keep aggregate demand in line with supply so that we can sustain growth over time and have a well-functioning economy over that medium term. We try to add it all up, and adding it up brings it back to this concept of aggregate demand.
Senator Harb: I see in your summary report that at some point you want to see a reduction of monetary stimulus. Perhaps you can comment on that.
In answer to my colleague you spoke about the account imbalances that currently exist. To what extent do we look at corporations such as Cisco that have outlets in China that produce goods that are brought back to the U.S. and sold to companies there? Does investment have a role to play in these types of account imbalances? Even though it is an American corporation that is producing the goods, it may not be on American soil. It may be on Chinese soil, but the goods are coming back to the U.S. and we suddenly have a current account imbalance.
The Chairman: That is a cluster of questions. To be fair to other senators, perhaps the governor can just answer that.
Mr. Dodge: In looking at those numbers on the current account all those things are taken into account. The issue is not that there is an imbalance. Let us be very clear. The risk is that the mechanisms that would correct that imbalance over time are not being allowed to work. That is what creates the risk down the line. It is not that the current account imbalances cannot be financed or that markets cannot work; it is, rather, that over time they have to be allowed to do their job.
The Chairman: I would like to introduce yet another new senator who is sitting on the committee for the first time, Senator Ruth from Ontario. Senator Ruth has great experience in many fields. We will look forward to her expertise.
Welcome, Senator Ruth.
Senator Oliver: I would like to extend my welcome to you, governor. It is nice to have you back again.
Since 9/11, the world has become more conscious of security. The Bank of Canada is charged with looking after the security of the financial system and protecting the integrity of our national currency, et cetera.
As I understand it, you have put in place a three-pronged program to try to strengthen security for Canadians. We hear about counterfeiting of banknotes. What new security measures have you brought in to ensure that our currency is not so subject to counterfeiting?
Mr. Dodge: I will speak to the issue of security and Mr. Jenkins will answer you specifically on the currency side.
Obviously 9/11 pointed out some of the fragility, if you will, in the system. Since that time, since the ice storm, since power failures and so on, we have expended considerable effort, as have the chartered banks, on building a more robust system that can function from backup sites.
It is fair to say that over the last five years we and financial institutions have spent a lot of time, money and effort to strengthen that system and make it more robust. That is equally true in the United States, as it is around the world. We have done much work to ensure that payments can be settled even though there may be a disruption.
Compared to where we were in September 2001, countries around the world, Canada in particular, have gone a long way toward making the system more robust.
I will turn to Mr. Jenkins on the issue of making the banknotes more robust.
Mr. Jenkins: You are right that we are pursuing a three-pronged strategy to enhance the level of confidence among Canadians in Canadian banknotes. You will recall that last year we issued three new high-denomination notes, the 20, the 50 and the 100. All three included new security features that we believe will contribute enormously to our battle against counterfeiting.
Senator Oliver: What has your experience been to date with those three?
Mr. Jenkins: The experience to date has been very positive. The counterfeiting numbers that we reported in our annual report for 2004 versus 2003 were up again, both in volume terms and dollar amounts. However, when you look through the year you see that, particularly in the case of these high-denomination notes, the level of counterfeiting is beginning to come down.
The next step we will take is to begin reissuing the $10 note in May with the new high-security features incorporated into it. The first prong is to incorporate those security features.
The second prong is what we call communications. Indeed, one of the best safeguards against counterfeiting is to ensure that Canadians recognize a true bill versus a counterfeit bill. We continue to work with our partners — financial institutions, retailers across the country and our regional offices — to further that part of our three-part strategy.
The third prong is working with the law-enforcement community in Canada.
Again, we have a number of partnerships under way that we are continuing to develop and move forward as part of that overall strategy.
Senator Oliver: Would that be with the chartered banks as well as the police?
Mr. Jenkins: Yes.
[Translation]
Senator Plamondon: I would like to ask you some questions about your mandate, which is to promote in a general way the economic and financial prosperity of Canada. My two questions will be about Canadians' savings and debt, and your recent positions on this.
I believe you said recently that you were in favour of the idea of investing pension plans 100 per cent outside Canada. Would that mean that the pension plan of Canadian government employees, provincial government employees and all pension plans could be invested in Canada? My understanding is they could. Could you confirm that for me?
Mr. Dodge: You said ``could?''
Senator Plamondon: Yes, ``could.''
Mr. Dodge: Yes.
Senator Plamondon: In that case, my concern is different, but I do have a concern nonetheless, because, in my view, these pensions should be invested in Canada to begin with. I am also very worried about the fact that the percentage that can be invested outside of Canada has been increased from 30 per cent to 100 per cent.
I come now to pension plans that are managed by interests outside Canada. I am referring to companies such as Home Depot, Wal-Mart and so on, which may have stores in Canada, have many employees, and take the pension funds and invest them in the United States, in their own interest. Could that be done? In the case of companies located in Canada whose head offices are in the United States, could it be decided to take the Canadian employees' pension funds and invest them in the United States?
Mr. Dodge: There are some rules known as the ``prudent person rule.'' That means that only a small percentage of assets can be invested in stock, in a company or in a bond issuer.
Senator Plamondon: These funds could be invested in several companies in the United States, could they not?
Mr. Dodge: Yes.
Senator Plamondon: I am very worried about this situation, because we are talking about the future of pension plans of all Canadians. Often, this is the only money these people will get. I am wondering how we can be so confident in the current economy to allow companies to invest up to 100 per cent of these funds outside Canada.
Mr. Dodge: Normally, the question is asked the opposite way. Here in Canada, particularly in markets for shares, not necessarily for bonds, but definitely for shares, we have rather limited opportunities because our companies are concentrated in natural resource industries and a few others, such as banks. Consequently, in order to try to diversify the assets of pension funds, it is extremely important to have an opportunity to invest in the shares of non-Canadian companies.
Senator Plamondon: Up to 100 per cent?
Mr. Dodge: Until recently, there was a 30 per cent limit, but the major pension funds had often invested more than that indirectly, which is not efficient for members of the pension funds. Now they can invest directly. However, all pension funds must pay pensions in Canadian dollars. Thus prudence dictates that they must have many assets in Canadian companies or in Canadian bonds.
So prudence does impose certain limits, but it is not necessary to impose further limits.
Senator Plamondon: My second question is about the debt of Canadians. Personally, I am concerned about this. You say your mandate is to promote economic and financial prosperity, and yet you defend bank mergers. Whether people talk about mergers, consolidations, or re-engineering, they are always talking about the same thing — to become more profitable, to eliminate the less profitable components. You spoke about ``credit unions'' that are prepared to take over if bank branches close. We heard the testimony of the former vice-president of the Canadian Banking Association, who now works for the ``credit unions,'' and who told us that he was ready to do this. However, we see Money Marts, payday lenders, and ATMs popping up all over Canada. As soon as they stop being profitable, they are closed down. The result may be better returns for shareholders, but it is not better services for Canadians.
I would like you to explain to me how you think better services can be offered during a time of rationalization? We have almost no major banks — we do not have the same system as the United States — and you are still in favour of bank mergers, even though we do not have many major banks.
Mr. Dodge: It is important to require financial institutions to provide services to Canadians. That is why we have a Bank Act. We can provide in the act that certain services must be provided to communities. That exists in Canada today, and the same thing exists in the United States. We can impose obligations on any institution that comes under federal jurisdiction. However, that is very different from restricting the consolidation of institutions. They are very different things.
Senator Plamondon: Every time there was a reengineering process, in Quebec for example, with caisses populaires, the result was the closing down of a number of caisses populaires. After they closed, the ATMs appeared and when they were no longer profitable, they were closed down. It is said that the services are provided; yes, but they are provided at a certain distance from the consumer. Not everyone can do their banking transactions by computer. Not everyone has a computer.
I have trouble accepting what you said about this leading to better services, especially with the proliferation of Money Marts and payday lenders. Furthermore, the Bank of Canada rate, which is 2.5 per cent right now, was 20 per cent in 1980, and the criminal interest rate was 60 per cent. The criminal rate is still at 60 per cent. I tried to bring that rate down by introducing a bill, but that bill will not pass. The Senate obeys the government and the government obeys a few ministers, and when a minister does not want a bill, it does not get passed.
[English]
The Chairman: Senator, I do not think that is fair. We will not take the governor's time to deal with this matter. We intend to pursue the senator's bill. We do have government business that takes priority. We will be pursuing that bill to some sort of conclusion.
Governor, you do not have to respond to that, but please respond to Senator Plamondon's question, which I think is important.
To emphasize her point, we have heard that in the vacuum created by the banks at the lower end of the spectrum, new institutions that charge very high rates of interest have filtered in and have grown tremendously in the last five years, that is, the money marts. Are the banking services under your aegis appropriate, and are they as fair to the people at the lower end of the spectrum as they are to the people at the upper end?
Mr. Dodge: We are not the best people to answer that, especially since we do not regulate the chartered banks directly. You should probably pose that question to Mr. LePan.
It is important to say that financial institutions are credit-granting agencies. They must make the appropriate assessment on credit. Part of the problem is that that is not always easy to do and it is not always pleasant to tell someone that they are not deserving of credit. That is where the loan sharks and various other entities come in.
As Mr. LePan will tell you, he keeps close watch on the credit-granting activities of those institutions. That is his job, so you should pose that question to him.
The Chairman: We are looking at the lacuna in the financial services and we thought you might be able to give us the benefit of your advice. We agree that it is up to you and to us as your oversight body to ensure that the system is working effectively and efficiently in the interests of all Canadians. You have a general mandate in this area.
Senator Plamondon, do you wish to follow up?
Senator Plamondon: I do not know if he will still be in favour of mergers after that.
Mr. Dodge: There are two or three questions here. One was on the issue of services available in the community, that is, whether there are ATMs and so on. Regardless of whether there is one bank or 100, that issue can be dealt with in the law.
The second question is on the credit-granting activities of banks. Generally the criticism is that they have been too free to give out credit cards, that they have allowed people to run up too much debt they cannot pay off. Indeed, part of the strength of the Canadian system has been that there is more careful granting of credit than there is south of the border.
Finally, there is the very important issue of how long it takes to clear a cheque, which gives rise to the money mart issue. A bank will put a hold on a cheque for what may for some be an unreasonable period of time. How to deal with that is a question for the law, regardless of whether there is one bank or 100.
Senator St. Germain: My question is about inflation. It is my understanding that the price of energy is not included in inflation figures.
Mr. Dodge: Yes, it is.
Senator St. Germain: It is reflected in inflation, as well as the cost of housing?
Mr. Dodge: Absolutely. The CPI is calculated on exactly what you buy. There is an item in the CPI for the electricity you buy to use in your house as well as for the natural gas and gasoline that you buy. Those are direct purchases. There are, of course, other big ones like intercity transport, which has very high energy content. It is fully reflected in the CPI.
Senator St. Germain: What do you think will be the long-term effect if the price of energy stays at its current level? It has more than doubled, and continues to rise on the market. Just today there was report out of the U.S. that this is starting to affect consumer confidence and consumer buying power. Have you any indication of what impact this will have? It is of concern to many Canadians, especially in Western Canada, where we travel long distances.
Mr. Dodge: I will take that in two parts; the long term and the short term. I will deal with the long term and Mr. Jenkins will address your question about the adjustments in the short term.
The rise in price curves out six to seven years. That will have two effects. First, it will bring on new supplies around the world, but that takes time. Second, it will cause investment, by both households and firms. Firms will invest in energy-saving methods of production and in households people will look at how they can economize, whether they really need an SUV or if something more fuel efficient will do.
That will happen over the long term. Therefore, while prices are likely to be higher over the long term than what we observed in the low-price 1990s, there are good market mechanisms that tell us that adaptation will be made.
The short term is more difficult.
Mr. Jenkins: There are several elements in the short term. I will make a couple of general observations and then go into a bit more detail. All the research we have done indicates that these types of oil price shocks are basically a wash for the Canadian economy. By that I mean, as you pointed out, senator, higher oil prices in the United States depress consumer demand; therefore our exports to the United States, all else being equal, would be fewer. However, we are, of course, a major energy producer, so this increase in energy prices represents a huge increase in the price of the products that we sell internationally. This is what economists call a terms-of-trade improvement.
There are two offsetting factors. On the one hand, it has a negative effect vis-à-vis our trading partners, but it has a very strong positive effect because we produce energy. Analysis shows that an increase in oil prices of $5 to $15 per barrel indicates that the overall effect on the Canadian economy over a couple of years is basically neutral. That is the macro story.
Linking to what the governor said, these higher oil prices reflect the fact that we have strong demand globally, much of it coming out of China, and it is not just for energy but for commodities more generally. To the extent that these higher prices persist, it will require an adjustment within the Canadian economy.
There will be a need for labour to move into the resource sector. For example, there is a shortage of labour to move projects forward in the tar sands area. These kinds of relative price adjustments require a reallocation of resources from one sector to the other. In our report we talk about global developments, and we talked earlier about imbalances. The other aspect of global investments is that energy and non-energy commodity prices are higher and likely to stay that way for a considerable time. They will require reallocations of resources across sectors of the Canadian economy.
The Chairman: Would you turn to page 20 of your monetary report? I listened to your argument about the tradeoffs between energy and non-energy supplies. It seems that the non-energy supply is flat, whereas the commodity index for energy has been climbing. I believe this relates to Senator St. Germain's question. They do not seem to be moving in sync.
Mr. Jenkins: Energy prices have gone up dramatically and non-energy prices have also risen. There is a scale problem with this chart. From the base level of late 2001, you are looking at increases of 30 to 40 per cent in non- energy commodity prices, which is quite significant. The story around metals is familiar and that is simply one indication of that.
[Translation]
Senator Plamondon: On the same subject, I would like a clarification. The Bank of Canada's website defines the core consumer price index as follows:
The CPI excluding the eight most volatile components.
The list includes fruit, vegetables, gasoline, fuel oil and natural gas. Is that energy?
[English]
Mr. Dodge: That is the core and we use it explicitly because it is a better measure of the underlying trend and future direction. Our target is the total CPI, and that includes energy.
Senator St. Germain: Are we in for any surprises or shocks?
Mr. Jenkins: Energy prices are volatile and so you want to examine those to determine the underlying trend in inflation. However, over time, the core rate and the total CPI converge.
[Translation]
Senator Plamondon: Do the eight most volatile components change from time to time or are they always the same?
Mr. Jenkins: They change.
Senator Plamondon: I do not understand. If they change, why was energy not included in the core components? What is the price of a litre of gasoline? It seems to me that gasoline, fuel oil and natural gas should be taken into account in calculating the inflation rate.
Mr. Dodge: Yes, they are included in the total CPI. That is what we are targeting.
Mr. Jenkins: What we are targeting is the total CPI.
[English]
Senator Massicotte: Do you think oil prices will remain at this level? Will that affect the economy in a negative way?
Mr. Dodge: We are no better than anyone else at making these forecasts. We use the curve as the market provides it. As Mr. Jenkins said, our best estimate, derived by using that curve of prices in the market, is that in 2005, the net effect on the Canadian economy is a miniscule negative and the net effect in 2006 should be a comparable positive.
Senator Moore: In the monetary policy report summary you state that:
One uncertainty around the outlook relates to the trend rate of growth of potential output.
The report also says that for the economy's production capacity to remain at a growth rate of 3 per cent:
...labour productivity growth will need to return to a trend growth rate of approximately 1 3/4 per cent going forward. The likelihood of such growth is supported by the recent and projected increases in business investment in Canada and by continued rapid growth in labour productivity in the United States.
I have two questions. Could you explain to the committee, and to me in particular, how growth in labour productivity in the United States impacts on the growth of the economy in Canada?
Mr. Dodge: In the United States in the late 1990s, there was a tremendous level of investment in the information technology and communications sector. That had quite a dramatic impact, beginning early in this decade, on productivity in the service sector in the United States. Our investment in ITC actually lagged that of the U.S., but has been improving. Our best estimate is that there will be considerable investment in this area in 2005 and 2006.
We have every reason to expect, although we do not know for certain, that what was observed following that investment in the United States, with a lag — an increase in productivity —we too will experience. That is why we say that although the last two years have been extraordinarily disappointing in terms of productivity growth, it is not unreasonable to assume that we will at least return to trend. That is not great performance, but we think it is reasonable to assume that for 2005-06.
Senator Moore: It is not portrayed accurately in the report, in that it is not the growth in labour productivity in the United States, but rather, the anticipated growth in Canada by virtue of the experience in the United States.
Mr. Dodge: That is right.
Senator Moore: That is not quite the way that it is stated in the report.
There was an article in the Financial Post a few days ago by Doug Porter, Assistant Chief Economist at BMO Nesbitt Burns. He talked about productivity and said that it is only necessary to look at what has been happening with the unemployment rate to believe the potential growth rate could be a lot lower than 3 per cent, perhaps 2 per cent. He said that overall growth in the economy was only 2 per cent in 2003 and 2.8 per cent in 2004, and yet the unemployment rate has plunged. We are growing only because we are hiring people. Our productivity growth rate is next to nothing and the rate of inflation will begin to increase without a rise in productivity. Could you comment on his statement and what you anticipate vis-à-vis inflation?
Mr. Dodge: That is precisely why I said that in 2003 and 2004 we had virtually no productivity growth and that all growth came from increased labour. We think it is reasonable to believe that in the short run, we will get back to at least trend productivity growth. Hence, the pressure on capacity would only begin to build if we had growth well in excess of 3 per cent, because currently we are a little below capacity.
Senator Moore: Will the productivity rate increase by the necessary 1.75 per cent? Are you hoping for that?
Mr. Dodge: There is good reason to believe so in the short run. Do we know for certain? No, and no one does.
Senator Gustafson: My questions also relate to oil and gas prices. In our community, we have two economies. We have an oil economy, and we have an agricultural economy. They are opposites. The oil economy is booming. I heard that they are expecting 50 new drilling rigs in one small area. They are hiring all the people they can find. In the agricultural economy, this is a negative. It is costing us twice as much for our fuel today as it did a year ago. Our fertilizer costs are way out of line. At the same time, our commodity prices and our sales of grains are dropping on the world market. The fear is that the inflated oil prices and the boom there could bring high interest rates. These farmers cannot withstand high interest rates. Right now, they are not borrowing money from the banks but from the machine companies, mostly from the United States, such as John Deere and so on. They finance the $250,000 combines and tractors. I would like to hear your comments on this situation. It is probably confined to most of Alberta and Southern Saskatchewan, but it has to have an impact on all of Canada as well.
The Chairman: To be fair to the senator, there is not only an impact in the West. It is a problem in Ontario, Quebec, the Maritimes, and certainly in British Columbia. It is a national problem, and it is a fair question.
Senator Gustafson: Just to add to that, I had a phone call the other day from a corn producer in Ontario who told me that he was getting $1.20 for good corn. That puts it into perspective.
Mr. Dodge: Senator, it is absolutely true that for industries where a large percentage of their input costs are related either to energy or, in fact, to non-energy commodities, costs have risen, and that certainly has squeezed profits, or squeezed farm income in the case of the farmers. There is absolutely no doubt about it. That makes life very difficult in those circumstances. Indeed, that is the working of the market, and over time there will have to be an adjustment. Less grain will be produced worldwide, and the price will then adjust. It is no comfort in the short run, or at planting time when you have to go out and borrow the money to put a crop in the ground, but that is how markets operate. I do not think that one can or should give anyone assurance that there will not be periods when this happens, just as there were periods when things went in the other direction and times were good. That happens to be the nature of the game.
Senator Gustafson: I would like to respond to that. The problem we face is a global one. The Americans subsidize heavily, and they will not stop that. We have heard that for 20 years. The Europeans do it as much, and they will not stop. Canada, if it is to have an agricultural industry, will have to take the global perspective. The countries that need our product the most have no money. That is a major problem. The Europeans and the Americans deal with it through subsidies. I will give you an example. We were growing peas in Saskatchewan. North Dakota, South Dakota and Montana started growing peas, and the Americans doubled the subsidies. Our bureaucrats in Ottawa tell us we will get them to stop the subsidies. I have heard that for 25 years, and it is not happening. However, we do have to look at another direction for the global economy of agriculture.
Mr. Dodge: Unfortunately, the Bank of Canada is not in that business, so you will have to take that up with someone else.
The Chairman: There is a disconnect. Senator Gustafson and I were in Utah. We spoke to agricultural committee chairmen in most of the states, trying to get them to reduce their pressure on their government and to reduce subsidies so that we could, in effect, compete. We have done it in Europe. It is a fundamental problem. All other countries are looking at maintaining the sovereignty of their nation based on having a sustainable agricultural sector. It is a deep and important problem that not only affects the West, but every region of the country. We have to come to grips with it, and we are looking for your wisdom here.
Mr. Dodge: I wish I had wisdom to offer, senator. I have a little farm as well, and it is not exactly profitable at the moment.
The Chairman: It is good that you are feeling the pinch like some other farmers. What can you do about it?
Senator Angus: We always wanted to meet a gentleman farmer.
Mr. Dodge: It does come right back to Senator Angus's very first question. We worry a lot about the pressure for protectionism around the world. Once one country starts doing it, the next does it and so on. Canada, being a very open economy, gets sideswiped in the process. That is why, on our side of the fence, when dealing with the international monetary order, we are doing what we can to ensure there are no disruptions that will rebound on the trade side, which would be a real disaster for Canada.
The Chairman: That, to my mind, is our answer. I am delighted to hear you confirm our viewpoints. We have been to these international fora and have been working at it. Frankly, we were concerned that one of the leading protectionists in the world and the leading protectionist in Europe is now about to become the head of the WTO. That does not augur well for our agricultural sector.
Senator Gustafson: I was at three bankruptcy sales in the last two weeks. These were large farms. One was 100 quarter sections. I lay that on the table. It is a very serious situation.
[Translation]
Senator Chaput: My question deals with reduction of the federal debt. Does reducing the federal debt have an impact on monetary policy and the various policies that are developed? Does the Bank of Canada have an opinion about how the surplus should be allocated when it comes to reducing the debt? Is it better to reduce taxes, pay down the debt or increase program spending?
Mr. Dodge: You would have to ask the Minister of Finance to address the last question. What is important right now from a monetary policy standpoint is to maintain a balanced budget at all government levels. That is important because, as we discussed last time, we have an aging society and, by the end of the next decade, government spending will have to increase in the areas of health and services for the elderly.
So a healthy fiscal policy enables the bank to be a bit more flexible in its monetary policy.
Senator Chaput: But is there more impact on monetary policy when the government emphasizes debt reduction or tax reduction? Does one or the other have more impact on monetary policy?
Mr. Dodge: For us, it is the balance that is most important. The Minister of Finance has to decide how to achieve that balance.
[English]
Senator Angus: Governor and deputy governor, you are aware of the interest of this committee in what appears to be less than ideal productivity in the Canadian workforce. In your recent commentaries and some of your documentation, you have deplored the fact that Canadian business has not been reinvesting in capital with a view to improving productivity. In fact, you stated in a recent study posted on your website that one of your main themes for this year is productivity and potential output for Canada.
Lately, of course, with the dollar rising in response to global forces, you have again been compelled to say that one of the things we will have to do in this country if we want to keep pace is improve our productivity and not let the low dollar, as it was four and five years ago, mask poorer performance by Canada in this area.
Could you comment on that, please?
Mr. Dodge: We are doing a lot of work on productivity. This is not easy analytically. The numbers are not all that great, so the analytical problems are not as tractable as some of the other things that we have to deal with. Moreover, even conceptually the problems are more difficult. That is why we are spending a fair amount of effort on the research side in trying to understand better what lies behind the relatively poor productivity in some sectors. One must be very careful here, because this is not universal.
From the numbers, we see that our performance relative to the United States seems to be poorest in the service sector. In manufacturing, while there are differences among some sectors and we do not have as good a performance overall as the United States, if we take out, for example, the sector that produces chips — ours is very small and theirs is very large, with a huge productivity gain — productivity seems to have been growing as rapidly as in the United States over the past little while. That is not satisfactory. We should be doing better in order to close the gap, but we certainly have not been losing distance.
We seem to be losing distance on the service side. That may be because our service industries have been slower in making investments in ITC technology. It may be that while they have made some investments, they have not made the organizational changes necessary to reap those benefits and so on.
If we look at the aggregate numbers, we can see where the larger discrepancies are. For that reason, and partly because we are in the business, we are concentrating our efforts as we go forward not only on trying to get a better handle on aggregate numbers but also on looking at the finance, insurance and real estate sectors to try to understand better why we have not been generating the same measured productivity gains in those sectors as the Americans have. It may all be measurement, we do not know; but that is what we are doing.
When we have some answers, invite us back.
Mr. Jenkins: Further to Senator Moore's question, in the forecast that we present in our monetary policy report, we really do see business fixed investment picking up. We see evidence of that from a number of different sources, including surveys that Statistics Canada undertakes. We do quite a bit of liaison work with companies across the country through our regional offices. The latest information there indicates as well that investment is ready to pick up in those areas that the governor was just talking about, including services. That is what gives us some hope that those productivity numbers will come back up to where we think they should be.
Senator Angus: As I know the chairman was about to say, of course you will be invited back. We are somewhat in limbo, and you will have to stay tuned to the Senate website, but we do hope to do a study on this.
I have to slip this question in before I defer to my colleague. My wily chief of staff is of the view that the exorbitant compensation packages for CEOs that Canadian industries bought into after the bad example of our neighbours to the south has had a deleterious effect on inflationary trends and other economic trends in this country. Can you comment on that?
Mr. Dodge: I have not had one of those salary increases, senator.
Senator Angus: Neither have we. In fact, there is a bill in Parliament that is trying to cut us further.
Mr. Dodge: I cannot answer that question. I have no idea.
Senator Angus: Can you comment, Mr. Jenkins? This is in the public domain. It is mentioned almost daily in corporate governance commentaries as one of the very bad things that has happened. It is almost like the hijack at the OK Corral by senior management in corporate North America in the last decade. It has skewed the whole economy.
Mr. Jenkins: With regard to inflation, average wage rates and unit labour costs, those areas that show pressures or the absence of pressures on inflation, there is no evidence at the macro level that the situation you have referred to is having any impact on the inflation numbers that we worry about.
The Chairman: Our study on productivity will be on May 11 and 12. If you would like to provide us with papers or evidence, please contact the clerk. It will be a two-day intensive study on productivity in Canada. We think it will be elucidating for us, Canadians in general, and responsible governments and businesses.
Senator Massicotte: I want to warn you, governor, that Senator Oliver gave me a summary of the comments you made earlier to the Canadian press. I hope you do not contradict what the press has reported that you said to the public.
I will return to the question of bank mergers. I did not feel you totally answered my question. That was probably purposeful, but I will allow you to say that.
We all agree that to an extent, consolidations and mergers afford greater efficiency. Obviously, that increases productivity and is good for the system. However, in making that statement one makes the assumption that there will be enough competition among the remaining banks to allow those savings to be realized by the users, and not only the sellers, the merged banks.
Does the Bank of Canada have an opinion? Has any research shown that if you make that assumption, three major chartered banks will provide adequate competition? Does the bank have any studies to show that merged Canadian banks would be successful financially, create head office jobs, and so on, as you referred to? Is there any study that shows that mergers would provide adequate service to the rural and small-business community?
Mr. Dodge: Let me take the first and the third question, which I think I can answer.
The evidence from abroad, where there has been consolidation, is that competition certainly has resulted in the benefits of that consolidation showing up in improved services or narrower spreads in the market. Since we have not had mergers, I cannot, obviously, answer that question in the case of Canada.
With respect to the desire of credit unions to expand their operations and take over where their big lumbering counterpart banks cannot provide very good service, we have seen evidence, with the movement of the Desjardins Group into Ontario, the aggressive position that has been taken by some of the B.C. credit unions, and from talking to the institutions that that would definitely be in the cards. Again, since we have not had consolidation, we do not know for sure that that would be the case.
Senator Massicotte: My other question relates to lack of international success of a larger Canadian bank because of the current status of our banks.
Mr. Dodge: Again, this will depend on the quality of management of the banks and the pressure on them to perform. Competition is the key here.
If we look at examples of consolidation in other countries, the banks have been able to take that platform and perform much better abroad. I do not know whether I am supposed to mention names here, but two good banks to compare would be the Royal Bank of Scotland Group and the Royal Bank of Canada Group.
Fifteen years ago, the Royal Bank of Canada was a bigger, more powerful institution than the Royal Bank of Scotland. The Royal Bank of Scotland, as you know, moved first to take over NatWest and some other bits and pieces in the U.K., and then parlayed that platform and some economies of scale to move on to the Citizens Bank and so on in the United States. They have been very successful. They have demonstrated very good management in doing that, but it seems undoubtedly true, from talking to them, that it was that scale that they were able to build in the U.K. and that platform that they could sustain that enabled them to bring productivity gains to the institutions that they have expanded into abroad.
You will find a little different story for some of the others, but if you talk to the Dutch banks, either ABN Amro or ING, that would be what they would tell you as well.
It is hard to be certain. If anyone tells you they are certain, do not believe them. Nevertheless, the evidence we have is that a larger scale would permit at least expansion abroad in a way that a smaller scale does not.
Senator Massicotte: To clarify the first part of your answer, I understood you to mean that even with consolidation of our five large banks to, maybe, three, in your mind there would be adequate competition to allow those efficiency gains. Is it presumed that any change in our regulations would include international banks coming to Canada to provide ATMs and so on?
Mr. Dodge: One of the things that undoubtedly would happen is that there would be some divestiture in the process of consolidation of domestic banks that could allow foreign banks to expand in Canada. Over time, it is important that the international competition be there in all fields.
I would stress that Canada must proceed segment by segment. At the moment, there is huge foreign competition in corporate banking. Those foreign banks do not need a large physical presence in Canada for there to be major competition. That is why having strong banks that do business globally is good for us, because then the employment is in Toronto, Montreal, Calgary, Vancouver, or even in Halifax. That is the situation with corporate banking, and it is, a fortiori, true in investment banking.
In personal banking there is more indirect competition now than we used to have, simply because it can be done over the Internet and does not require physical presence.
It is absolutely true that we assume that foreign competition will continue to increase and it is very important that market pressure be put on our institutions to perform. When the pressure is there, they do perform.
[Translation]
Senator Plamondon: I do not understand how increasing foreign investment from 30 per cent to 100 per cent can help Canada's economic prosperity, when we recognize that there is a great deal of unemployment in Canada. How can we pretend to be reducing unemployment in Canada by using as a measure the increase in foreign investment from 30 per cent to 100 per cent? How can you say that bank mergers will result in better services when you acknowledge that credit unions or Caisses populaires Desjardins will have to replace the branches that will close? They too will have to consolidate and they will have to take the most profitable opportunities in order to position themselves in the market. They will also end up closing some branches. It is a domino effect. It has a cumulative effect. The banks merge and the credit unions take their place. The credit unions have to consolidate because they need to invest and so they will let some branches go. It is the little guy who ends up with no services. The others will always have services. If you go into a bank today, you do not get charged anything and the manager will fall at your feet. Things are different for the little guy.
Mr. Dodge: You are asking a lot of questions there.
[English]
The Chairman: Yes, but please respond to the one related to the supplemental question, which is the merger question, if you could, governor. We want to follow that line further.
Mr. Dodge: Mr. Chairman, let us be clear. What we have been talking about is trying to improve the efficiency of the financial sector. It is the efficiency aspect that is so important.
The only question is, do we get more efficiency by imposing some restrictions on what financial institutions can do, or are we likely to get more efficiency and more innovation and more pressure on those institutions to perform by saying that there are two things that we really want to do: First, through the Superintendent of Financial Institutions, make sure that they operate in a prudent fashion and are financially solid; and second, through the Competition Bureau, ensure that they meet the standards of competition that we set out. We want the pressure of the market to make them perform.
We have seen in other industries, and indeed within the financial services industry and the insurance industry, that when we take away the restrictions, they do perform and we get better services. Certainly our whole history since the 1967 major Bank Act reform has been that by taking down barriers, we get better service and more efficient operations.
Senator Moore: Mr. Governor, you talked about what has happened in terms of bank mergers in other countries. You mentioned that one of the results was improved services. We have been holding a lot of hearings here with regard to consumers' rights and services for consumers. When you talk about improved services, are you talking about services for the consumer? Are you talking about services to the big corporate clients? What did you mean by that? What was included?
Mr. Dodge: Generally, the one measure we can use across all countries is spreads, and spreads have tended to narrow. They narrow for consumers, and they narrow for business borrowers as well.
Senator Moore: I am talking about the actual banking services available to consumers.
Mr. Dodge: The trouble is, senator, over time, technology has brought about so much change that to try to attribute that to consolidation or not is very difficult.
The one thing that you can measure over time and know what you are getting at is the spreads, i.e., the difference between what the bank pays you as a depositor or as someone who buys their notes and what they charge the customer. Over time, we have seen that as consolidation takes place in various markets, it really does squeeze those spreads.
[Translation]
Senator Biron: If we agree that bank mergers would be a good thing, would mergers of banks with insurance companies also be a good thing?
Mr. Dodge: I do not know exactly if it is bank mergers, insurance company mergers or just mergers that are important. It is important to have the impression of competition. It is up to them, not the government or the Bank of Canada, to decide whether they should merge or not. It is up to them to find the most profitable way to operate at the beginning. It creates pressure for better services.
That is not an argument in favour of mergers, but rather an argument in favour of letting the market forces operate and letting the market do what it can to provide better services to Canadians.
Senator Biron: What effect can the American economy, in view of its huge deficit, among other things, have on Canadian interest rates and the Canadian economy as a whole right now?
Mr. Dodge: There is no doubt that if the American economy is doing well, if consumer's spending stays high, and the United States invest, it will be a good thing for us. If things slow down, it is not good for us. It is quite simple.
Senator Biron: The huge deficits in the United States right now will certainly affect interest rates, is not that right?
Mr. Dodge: Yes.
Mr. Jenkins: Regarding the enforcement of Canada's monetary policy, the fact is that we have a floating exchange rate which gives the Bank of Canada the independence it needs to manage our monetary policy in accordance with the needs of the Canadian economy. The floating exchange rate gives the bank autonomy over our monetary policy. Changes in American interest rates do not directly affect Canadian interest rates.
[English]
The Chairman: I have a brief supplemental question on that. This is a fundamental question that all senators have been asking. What really is the resilience of the Canadian economy, the financial sector and the capital markets of Canada to a downturn in the United States, having in mind the huge and growing deficit, the inherent weakness of the American dollar, based on the fact that a lot of it is in the Asian marketplace — and we saw a ripple of that just a few days ago — and the credit exposure in the United States and in China? Are we sitting on something of a time bomb, having in mind that the American economy is so asymmetrical in terms of these numbers? I think that is what Senator Biron was trying to get at. We are worried about a downturn based on the fragility and asymmetrical nature of the American economy at this moment.
Mr. Dodge: We are really going right back to where we started.
The Chairman: We are. I think we are still not comfortable, and that is why Senator Biron raised this. Others have raised it indirectly. We are not comfortable with this. Is there anything more we can do now as opposed to waiting to be confronted by a huge emergency?
Mr. Dodge: There are two sets of issues here. One is what can we do, working internationally, to try to put in place conditions such that a downturn is less likely to occur in the future? What we do is engage on the monetary order side, and that is precisely what we have been trying to argue at the IMF and the G7 — that steps need to be taken to reduce this potential risk in the future and allow the corrections to take place in an orderly fashion. Undoubtedly, what would be really bad for the world, and really, really bad for us, would be a collapse in American demand without a commensurate increase in demand elsewhere in the world.
[Translation]
Senator Massicotte: I would like to change topic, if I may. I would like to talk about demographics. There have been a lot of studies.
[English]
The Chairman: I apologize, Senator Massicotte. Senator Moore has a brief follow-up to ask first, and you will have a few moments later.
Senator Moore: When you talked about productivity, Canada versus the U.S., you said in the service sector we were negative, and in manufacturing we were on the positive side. Within the service sector, you mentioned financial and insurance services. Would that change if there were mergers?
Mr. Dodge: We do not know. First of all, we do not know why the numbers are as they are, whether it is the banking sector, the life insurance sector or the general insurance sector. The largest component of that is actually real estate. We do not know the answer to that because we do not fully understand what the numbers are telling us.
Senator Moore: I thought our insurance industry was quite robust.
Mr. Dodge: This is why I say that we do not fully understand the numbers. Our life insurance sector seems to be highly competitive worldwide. The simple measures on the banking side, apart from how we measure the GDP, indicate that we should not be lagging that far behind the Americans. We do not know and so I will not try to answer that question.
[Translation]
Senator Massicotte: You talk a little about demographics. Since we hear a lot about this, we know that the Canadian population is growing older on average. Recent studies have shown that if the average age of Canadians does not change, the GDP will fall by 13 per cent within 20 years. That is a huge decrease, and these studies are worrisome. There are two or three hypotheses, and this has an impact on immigration levels. Does the Bank of Canada study demographic trends in Canada in connection with the economy as a whole and the impact on government in the future as a result of rising health care costs? If so, are there policies or documents that you would suggest we look at to improve how we can respond to those projections?
[English]
The Chairman: Mr. Dodge, Senator Massicotte persuaded this committee to look at the demographics of economics. We are most interested in this particular question and so I thank the senator for urging us to accept this as a term of reference.
Mr. Dodge: As I said earlier, we know that sometime after the middle of the next decade, unless there is a great change in labour force participation behaviour, we will be in a position where the growth of the labour force will slow almost to zero. Under certain hypotheses, when you go out to 20, 25 or 30 years, you can see it turning negative.
Regardless of the precise numbers, the implication is the same: First, growth will have to come from additional output per worker in the labour force and, hence, the emphasis will be on productivity. Second, we will have to look at the most efficient ways to get young people into the labour force and make them productive, while at the same time allowing older people who want to continue to participate in the labour force to find ways to do so.
If we are able to do that, then the slowdown in the growth of the labour force will not be as rapid and we will be able to adjust more smoothly; and we will have to adjust. That is why demographics tie into so much of this. It is important for the Canadian government to run a fiscal balance over the next while so that the debt-to-GDP ratio comes down quite smartly over that period. Then, when we face these demographic problems at the end of the next decade, governments will have some room to manoeuvre at that time without relying on additional taxes on the working population. It is an extremely important topic.
[Translation]
Senator Chaput: In the economic adjustment that Canada is currently undergoing, there is the information and communications technologies sector which, as you indicated yourself in your report, has shown sluggish growth to this point. That is understandable because things change so quickly. It takes more and more investment in employee training and equipment acquisition. Colleges and universities are no longer able to acquire state-of-the-art technology to train people who are there now and those who will be coming. Do you really believe that this sector will be able to catch up over the next few years?
What percentage of the Canadian economy is driven by the information and communications technologies sector? Is the services portion high enough?
Mr. Jenkins: In the manufacturing sector, it maybe a total of eight per cent, and that is certainly less than in the United States. That point was made by the governor. Productivity in this sector in the U.S. is higher than in Canada. It also reflects the fact that we are still adapting to these technologies, which is very important for future productivity.
Senator Chaput: Will we be able to adapt? In the next few years?
Mr. Jenkins: Yes, that is our hypothesis. Absolutely.
[English]
The Chairman: Governor, I have a few short but complicated questions.
First, I want to deal with your statement, the comments at this hearing, on bank mergers. I believe that I am speaking for all members in saying that the committee has suspended judgment on this question of consolidation. We will wait for the government to issue its paper and then we will attack the question, as you have suggested, not as a macro issue, but rather as a micro issue in terms of what is necessary in the nature of the consolidation to reach the ultimate goal of improved efficiency and fairness.
We have been plagued by questions, but this committee, unlike other committees, is keeping its powder dry. We want to see the questions that will come before the committee and we will explore them when the government asks us to do so. If the government chooses that we not do so, we will do it in any event. We have one area to yet consider: the impact on and efficiency of cross pillars.
I thought it would be important to put that on the record, as you put your case on the record.
Senator Angus: We do deplore the fact that the guidelines have been so long in coming.
The Chairman: There is some political concern about when the guidelines will be available, but we are bipartisan in this committee. We are concerned about the questions and we will look at them.
I want to deal with the question that you raised, of efficiency in the financial sector. We have heard a lot of evidence from our consumer study and related issues that there is inefficiency in the regulation and distribution of securities, in that market. It is a common issue. We are the only G8 or G7 country that does not have a central regulatory commission.
We have been grappling with this. We cannot change the political situation vis-a-vis the provinces trying to get together on this. They are inhibiting efficiency in our view, but we cannot change that. However, like the Americans, we could set up a central regulator in Ottawa, using federal powers. Have you any views on that?
Mr. Dodge: My views are clearly on the record. They do not relate so much to whether you have one regulator or a system of regulators, but to having a set of consistent regulations that deal with three different kinds of issuers in this country.
We have issuers such as the Royal Bank and Nortel that will have to go to international markets. For that, they will require rules similar to those of the New York Stock Exchange, because that is where they will have to go.
At the very bottom of the totem pole in terms of size we have the junior mines. The junior mines do not need all the apparatus of that kind of regulation. They have to obey the principles, but they need a much-simplified compliance procedure.
In the middle we have the vast majority of Canadian enterprises, which in world terms might be micro-cap. By our terms they are mid-cap. They do not really need access to the New York market, but they certainly need access to the entire Canadian market, where some form of compliance procedures, simpler than New York imposes but obviously more detailed than what you would want for a junior mine, are necessary.
The real issue is to try to come up with a set of rules that covers these three rather different sets of issuers to allow them to use the public markets efficiently. Whether that means one regulator or 13, it certainly does mean an agreement on a common set of rules and regulations and a common enforcement procedure to deal efficiently with these three different groups.
My worry is that we have to get on with getting that rule structure in place. I was engaged in this in 1996. We have been talking for a long time and have not made as much progress as we should have.
The Chairman: You have understood our point. The point is that those who should be most concerned with efficiency at the provincial level are not moving as quickly on the harmonization or the unification as we would like. It is an endemic problem. We will be exploring this in our productivity study and other studies. We have two upcoming studies, one on productivity and one on provincial barriers to efficiency. I am delighted that you have joined your voice to ours in looking at this.
There is a big issue of asymmetrical federalism with regard to debt. The provincial debt of Quebec is $86 billion. The Ontario debt in 2004 was $138 billion. The argument of both those provinces is that there is an asymmetrical relationship between their ability to pay off that debt and that of the central government.
Have you given any thought to this question as it affects the efficiency of the country?
Mr. Dodge: Our public debt markets in this country, be they federal, provincial or corporate, operate pretty efficiently. I do not think there is anything in the operation of those markets to indicate that there are great inefficiencies. Clearly, the markets continuously price provincial debt in relation to their perceived risk, and obviously it is priced at more than Canada debt. However, there is no indication, as far as I know, that markets are operating in such a way that they are not being appropriately priced.
The Chairman: On that pleasant note, governor and deputy governor, I want to thank you.
During the course of this hearing, 15 per cent of the members of the Senate were here, listening and participating. It was probably the largest hearing of its kind since Confederation.
Thank you very much. You are a great attraction.
Mr. Dodge: We were very pleased to meet your new colleagues and to be in this fancy room. I hope we will use this room for our future hearings.
The committee adjourned.