THE STANDING SENATE COMMITTEE ON BANKING, COMMERCE AND THE ECONOMY
EVIDENCE
OTTAWA, Thursday, October 5, 2023
The Standing Senate Committee on Banking, Commerce and the Economy met this day at 11:29 a.m. [ET] to study the Government Response to the fifth report (interim) of the Standing Senate Committee on Banking, Commerce and the Economy, entitled The State of the Canadian Economy & Inflation, deposited in the Senate on February 15, 2023; and, in camera, to consider a draft agenda (future business).
Senator Pamela Wallin (Chair) in the chair.
[English]
The Chair: Hello to everyone, and welcome to this meeting of the Standing Senate Committee on Banking, Commerce and the Economy. My name is Pamela Wallin, and I am the chair of this committee. I would like to introduce the members. We have with us today, Senator Bellemare. Welcome back, Senator Smith, who is filling in for Senator Deacon today. Senator Gignac is here. Our deputy chair, Senator Loffreda, is also here. Senator Wells is sitting in for Senator Marshall. We also have Senator Martin and Senator Massicotte. Senator Galvez is visiting today. Senator Ringuette might be joining us in a moment. We also have Senator Petten and Senator Yussuff.
Today, we have the great pleasure of welcoming David Dodge, Senior Advisor at Bennett Jones LLP. Of course, he is here because he is the former governor of the Bank of Canada and always has interesting, sometimes even provocative, things to say about the state of the economy. Mr. Dodge, the floor is yours.
David Dodge, Senior Advisor, Bennett Jones LLP, and former governor, Bank of Canada, as an individual: Good morning, senators. It’s a great pleasure to be here with you. I can remember 50 years ago. It was the first time I came to the Standing Senate Committee on Banking, Commerce and the Economy after the 1972 budget. The reception was not totally friendly at that particular time as we tried to defend some of the things we had in that budget. But it’s great to be back with you.
My opening comments are simply to provide a bit of background for our discussion today on the outlook for growth, inflation, debt and interest rates.
I just want to start with an observation that we are in a period of rapid and extensive structural change in our economy and the global economy — change to which we must adapt. We have demographic change. The life expectancy at age 65 is increasing rapidly, and that means we need increased investments in health and other care facilities. At the same time, we need increased saving by workers to prepare themselves for an extended period of retirement. We have climate change, and dealing with climate change requires increased investments, adaptation to higher temperatures and the reduction of greenhouse gases.
We have had a change in the global trade order. Adapting to a more fragmented global economy applies additional domestic investment to improve security of supply.
Finally, there has been technological change. Artificial intelligence, or AI, and digitization offers great hope for future increases in productivity, but in the short term, they require very significant increases in investment, particular in intellectual property, digital systems, research and development, and human capital.
But raising productivity to facilitate adaptation to those four changes requires business, households and governments to devote a larger share of their representatives to investments in productivity-enhancing machinery, equipment, infrastructure and intellectual property than they were doing in the decade prior to the shock of COVID.
While, in principle, some of that investment might be financed by borrowing, here in Canada and in almost all advanced economies, debt levels are high and savings are weak. Thus attempting to finance all these needed investments by borrowing is resulting in increased upward pressure on prices and interest rates. This will likely continue over the next decade.
Faced with this reality, it means that in order to make room for increased investment spending, business will have a smaller share of their retained earnings to distribute to shareholders, households will have a smaller share of their incomes to devote to current consumption as they increase savings and governments will have a smaller share of their revenues to devote to the provision of current services to citizens.
Devoting a higher share of revenues to investment is never easy, but it can be managed more easily if incomes are growing fast at the same time. Unfortunately, real incomes are not growing quickly because productivity has been weak. Indeed, on a per capita basis, output has been falling recently. Additionally, the share of income that must be devoted to servicing past debt has arisen and will remain well above pre-COVID levels for the foreseeable future.
Canadian households are curtailing and will, unfortunately, have to continue to somewhat curtail current consumption in order to increase savings and, in so doing, adapt to these structural changes.
But governments face precisely the same issue as the households. Investment requires a greater share of revenues to facilitate adaptation to the four structural changes at the same time as charges for public debt incurred in the past eat up an ever-larger share of revenues as interest rates rise. In a period where interest rates are projected now to be roughly equal to growth rates rather than well below growth rates, new borrowing to finance additional services for households or support for business investment will simply raise the fraction of revenues that have to be devoted to interest charges and will further curtail the government’s capacity to invest today in order to provide services for the future.
Governments really cannot borrow their way out of the difficult choices involved in the reallocation of resources needed to free up room for the investment required to adapt to structural change. On average, over the next few years, budgets are going to need to at least come close to being balanced to provide room for additional public investment and support for private investment. Either the growth of government-provided current services or transfers will have to be somewhat reduced, or alternatively, taxes on private consumption will have to increase. However unpalatable such a choice might be in the short term, failure to invest in adaptation today would indeed condemn Canadians to a much more unpleasant future.
Senators, I hope I have given at least some background to facilitate discussion.
The Chair: Thank you very much for those comments and your latter words, particularly, reflecting the last report that this committee put on the record in June. Thank you for that.
Can I have a quick comment from you following up on the others? In terms of bonds — 10-year, 30-year — way down — selloff is high. What does that signal to you about how they are reading either government actions or the market itself?
Mr. Dodge: I think markets are finally catching up with the reality of what’s going on in the world. It’s taken awhile. There was a hope or a thought that the structure of the economy following the adjustment to COVID was going to look like the structure of the economy we had after the great financial crisis. In fact, my argument — and I think it is now increasingly being accepted — is that all these changes that I talked about that are going to require additional investment means that the demand forces are going to be stronger than they were over that period; the demand forces in the private sector are going to be stronger than they were over that period. We also do face continued restriction in the amount of global supply, which means that we face upward pressure on prices and on interest rates as we go forward.
We’re trying to adjust now to a world where that is the case.
The Chair: Great. I’ll follow up on that later on. Now we will go to the deputy chair.
Senator Loffreda: Thank you, Mr. Dodge, for being here with us.
Housing affordability is a major concern for our economy. What would be your top three recommendations in terms of the policies the government should adopt to address the housing crisis?
You have lived through previous housing crises. We always had a demand-supply issue in Canada for many years — in the 1980s and for numerous years. I was reading a Canada Mortgage and Housing Corporation, or CMHC report, and it said that at least $1 trillion is needed to achieve housing affordability. They were looking at 3.5 million homes to close the affordability gap by 2030.
Those are large numbers. How can it get done? Do you have any policy recommendations that could be adopted?
Mr. Dodge: The market is giving us signals right now that more has to be invested. The prices are rising in order to do that. At the same time, interest rates are rising, which are going to force additional savings. Markets are forcing an adjustment, however unpleasant that adjustment might be. We can’t ignore what is going on.
But we face a real problem, because if we are to invest more in physical capital to increase production and if we are to invest more in our labour force — all of that, at the same time — we need to invest more in housing — those are exactly the price signals we’re getting from the market. In the end, that means households collectively will actually have to save more in order to release the funds.
So there is not an easy solution to either building housing or making the investment in industry that we need in order to increase productivity in the future.
That’s the world we’re living through. There are no quick fixes. To the extent governments were to decide that they want to buy us, if you will, savings to be directed toward housing rather than directed toward improving capital equipment and raising the amount of capital equipment per worker to the extent to which we need, then we actually threaten future productivity growth.
There is not an easy solution. We are going to actually have to live through it, and it means that the share of household income in the end that gets devoted to housing either through interest rates or through rental payments is actually going to have to go up. That is the difficult choice.
There is not an easy answer.
Senator Loffreda: I have a quick supplementary.
Talking about policies, I agree that there is no quick, easy answer, but do you feel the GST forgiveness for new rental units is a good policy? That is the new Bill C-56 tabled by the government. Should there be more incentives for our builders to increase supply? It is a supply issue. I remember in the 1980s, there were many incentives for builders and buyers. Do you see those kinds of policies being effective? Should the government create more of those policies?
Mr. Dodge: We ought to say, “governments.” Let’s be careful. Three levels of government are intimately involved in this issue.
But let’s be clear: To the extent that government revenues are diminished or subsidies are provided to try to increase housing investment, that leaves government with less room to do other things. There is a very real question of whether you want to bias — and I use that in a positive sense, not in a negative sense — if you want to provide additional incentives for investment to go into housing as opposed to providing the additional capital, equipment, IP, R&D and so on in industry, which would raise productivity in the future, that’s a very tricky issue.
You would really like increased investment, both in housing and in real capital equipment, that, by arithmetic, means you are going to have less for current consumption services.
[Translation]
Senator Gignac: Welcome, Mr. Dodge. It’s always a pleasure to see you. While you are here, I would like to talk about a more topical issue: inflation.
The world has changed. Unlike in the previous cycle, many of the problems are now on the supply side. Monetary policy is less effective. More and more people, including some here in the Senate, have joined my colleague in suggesting that the 2% inflation target might need a rethink. It might be very difficult for central banks to maintain the 2% inflation target. It might even trigger a recession. Do you have an opinion as to whether central banks should absolutely maintain the 2% inflation target in this context?
[English]
Mr. Dodge: That is a really interesting question that I think everybody is asking at the moment.
The way I would answer it is, first, to go back in history. We ended where we are, at 2%, having gone through a period where we had disinflation targets. We worked through that and ended that period in 1990 with 2%, and that’s sort of where we stopped. The logical argument to have a higher number is that, in a period where relative prices are moving all over the place — some going up and others having to come down — the downward movement in prices — negative increases — and wages, going negative is much more difficult than going from an increase of 1% to 0.
The argument is that since there is an asymmetry in the way that markets adjust, you really need a bit of a higher target rate in order to facilitate adjustment where some sectors’ prices don’t move down as much as they need to in order to offset those that need to go up.
That is the logical argument for a higher number. There is no particular higher number that you can take that will do that, but that is the argument for a higher number.
I would argue that we now have 20 years of experience where downward movement in prices has proven to be quite possible — more possible than we might have imagined in 1990 when we were starting this. Adjusting to the volatility of prices is, in my mind, not as strong an argument as it might have been in 1990.
That’s number one.
Number two, I think we have really benefitted from the certainty that prices would more or less be in the 1% to 3% range, focusing on 2% now for 30 years. That is a piece of public capital that is incredibly valuable.
If you lose that piece of public capital, if people then become uncertain as to where things are going to rest, whether it’s in labour negotiations or negotiations between suppliers and vendors, then we have an economy that just doesn’t function as well. The market economy doesn’t function as well.
In the end, I come out quite strongly on the side that given where we are, given our starting point, staying with the 2% target is really important, and really important to stay there, and any short-term help that you might get from moving that target is way overcompensated by the longer-term harm.
Senator Gignac: In certain environments, what will be the role of public fiscal policy? Do you favour having budget anchors? A few days ago, it was anchors to the debt-to-GDP ratio target, and now they no longer have a target. Do you favour that? Is it helpful for monetary policy to have a fiscal policy with anchors?
Mr. Dodge: Absolutely, that is true. Precisely what the anchor should be, is always a bit debatable.
The Chair: What do you suggest?
Mr. Dodge: In a world where the growth rate of the economy, and hence the growth rate of government revenues is not going to be terribly robust and is likely to be only about the same rate as the rate of interest that the government has to pay on debt — so no longer will growth rates exceed the rate of interest by 2 or 3 percentage points — when you are in that situation it really does force you back to having an anchor which, at least over the business cycle, should mean that your deficit does not grow in real terms.
[Translation]
Senator Bellemare: I will ask my question in French. Welcome and thank you for being here today. You may answer in English to be more concise.
I would like to pick up on my colleague’s question. Is there not a contradiction right now, in light of the challenges you mentioned, and a contradiction in the bank’s own record of proceedings, which says that its policy reduces investment? Is there not a contradiction with the monetary policy of high interest rates? I am not referring to the target; I mean the use of that tool, that is, the policy rate, to fight inflation while we have major challenges related to investment.
Are there no alternatives to reduce demand that are much more targeted than the policy rate?
[English]
Mr. Dodge: The bank itself does not have an alternative tool. Government has alternative tools. Government has tools that can modify the impact of change across industries and across income classes. The bank does not have that tool, so the bank is using the one tool that it does have, which is restricting credit conditions through increase in the policy rate. That’s what it is doing.
That is the reason, senator, why our Bank of Canada Act requires the government and the bank to consult regularly — the Minister of Finance and the bank to consult regularly — because there are two tools, essentially, operating here to manage demand.
The government has a very flexible tool. The bank has a much less flexible tool to deal with it. So it’s really important that — I don’t want to use the word “absolute coordination,” but at least both the government and the bank understand exactly where they are trying to get to, because we all have exactly the same targets. We would like is the economy to be stable, grow, and a reasonable distribution of income. It doesn’t matter what the government or the Bank of Canada wants, we all have the same objective, but the government has many more tools than the bank does to balance that.
[Translation]
Senator Bellemare: Do you think there should be a mechanism to make that coordination more regular and accepted?
[English]
Mr. Dodge: The legal framework is exactly right. What it requires is that the two parties do sit down. In my experience — certainly when I was there, and I think it is true — the dialogue between the staff at the Department of Finance Canada and the bank — and, indeed, in my experience, it was between the Prime Minister and the bank — the dialogue takes place. You don’t necessarily agree, but the point is you have to discuss it. It’s out of that discussion that we get the best —
[Translation]
Senator Bellemare: Let me just say in closing that the legal framework is not all that rigorous.
[English]
Senator Galvez: Mr. Dodge, I know you are a legend for many members of the Banking Committee, and I know of your work through the C.D. Howe Institute.
In your earlier testimony for the fifteenth report, you highlighted the issue of climate change, and you just mentioned it right now, too. You said, “Dealing with climate change requires increased investment in adaptation to higher temperatures and more frequent storms . . . .”
I want to pick your brain in two areas where climate change disrupts the system. First with respect to insurance. For example, in the discussion, I heard in 2020, a major insurance company was in danger because there were extreme weather events in several provinces. The same thing for the bank, and, of course, you mentioned the need for workers and pension plans to take care of the future.
What do you think is the impact on the financial sector due to these climate change and extreme weather events that destroy basic infrastructure?
Mr. Dodge: Certainly for the insurance sector and the financial sector as a whole, climate change and the impact on global agriculture, the impact in terms of forest fires, the impact of floods and so on, have, basically, increased uncertainty, and increased uncertainty has a cost. That is, in the simplest terms, the impact on the financial system. It is less stable, if you will, because of climate change than it was before, and that’s the uncertainty factor.
Senator Galvez: Thank you. You know that the U.S. has the Bipartisan Infrastructure Investment and Jobs Act and the Inflation Reduction Act, and our economy and the U.S. economy are so intrinsically related. How do we appear if we don’t bring up our game with respect to the issues regarding climate change?
Mr. Dodge: That was precisely the question that I was trying to address when we talked about housing. In both instances, it means we have to consecrate more of our resources, whether the governments’, households’ or industry’s — we have to concentrate a bigger share of our resources to investment. They are competing investments: housing versus industry versus dealing with climate change.
There’s not a clear, easy answer to that, but there is one unassailable conclusion: We have to devote a greater share of our household, business and government resources to investment in all of the areas we just talked about. That inevitably means, if we’re honest, that we’re going to have to forego a little bit of current consumption in order to release the real resources to make those investments.
That’s just the world we’re in. It’s not an impossible world, in the sense that if we do it right and do make the investments, the outlook in 2030 looks a lot better. If we don’t, the outlook in 2030 really doesn’t look very good.
But it’s a very hard message to bring across, and it inevitably raises the challenge for governments as to how that restriction, if you will, on current consumption — what the distribution of that is going to be.
The Chair: And how you force that to happen.
Mr. Dodge: Right.
Senator Massicotte: Thank you, Mr. Dodge, for being with us this morning. It’s much appreciated. Your intelligence is also extremely appreciated.
Let me simplify a few assumptions. There is no question we have to spend more money on investment and less on consumption. I think that message is clear. It’s one you’ve given us for a couple of years.
If I were to assume, though, given human nature and the choices we have, the government would probably choose not to do much and let things evolve without them pushing a button or making a major announcement about investment. What scenario do you see if you make that assumption and just let it occur, blame somebody else but you don’t get to a solution? What do you think of that?
Mr. Dodge: I have always argued that it is much better public policy to be proactive than to pick up the pieces after the fact. Undoubtedly, it is easier to pick up the pieces after the fact; it seems easier to pick up the pieces after the fact. The experience that we’ve had would argue that, no, it is actually more expensive to pick up the pieces after the fact.
We went through it in the 1970s not making some of the adjustments we had to make, and we then had in the early 1980s a very difficult period. Everybody will remember. We allowed the financial markets to go a bit wild at the end of the 1990s, and we had two major hiccups: We had a crash in the stock market in 1990 and the great financial crisis in 1997.
Alan Greenspan at the time argued forcefully that we’ll just pick up the pieces after the fact. Picking up the pieces after the fact in 2008 resulted in 10 years of really bad performance. I would argue that, as difficult as it is, standing up and being honest about what it is we have to do in advance is much preferable to figuring that we’ll just pick up the pieces at the end.
At least the last 50 years of experience would take you there. It’s hard, but if we’re all honest about what it is, Canadians are pretty realistic folks. If we all understand what it is we’re up against, then we can move ahead and do it.
Senator Massicotte: I’m not sure you answered my question; I know your wishes anyways.
Having said that, let’s go forward to the American situation. Their economy is different than ours. They have a lot of stimulus going on. How do you see the scenario there in the next five years for the American economy?
Mr. Dodge: The American economy has some problems that are more deep-seated in some ways than ours. The U.S. federal government carries an enormous amount of additional debt compared to Canada, and the prospects are far worse.
We have a difficult period to go through.
I would argue — and this goes back to your first question a little better — the Federal Reserve has not been nearly as restrictive as they thought they were being in terms of their interest rate movements. A year ago, I thought that we would top out at something closer to 5% or 6% in the U.S., and that was probably what was necessary to open up enough of a gap between the supply capacity in the economy and the demand in order to actually bring things to a halt.
I think now the markets are coming to the exact conclusion that the world has changed and that the underlying neutral rate is higher than what either the fed or the Bank of Canada advertises at the moment. Exactly what it is we don’t know; we will never know until after the fact. It’s probably rather than in the range of 0% to 1% real, it’s probably in the range of 1% to 2% real.
The impact of the restrictive policies that both the fed and the Bank of Canada has not been as big in real terms as, analytically, the bank and the fed thought they were actually having. That’s not a criticism, because we learn as we go, but that is the case. If you have a new neutral rate for the Bank of Canada, rather than being between 2 and 3, it’s probably somewhere between 3 and 4. Former deputy governor Paul Beaudry gave a very good talk on that recently. In today’s Toronto Dominion Bank letter, there’s a very good note on this. It’s not exactly as I would have written, but at least it’s a clear explanation of why it is we think these market rates are going to be higher.
The Chair: Thank you for that. We will look that up. I saw that same statement from Mr. Beaudry.
Senator Yussuff: Thank you, Mr. Dodge, for being here.
You raised some important questions that time has caught up with us. We’re all getting old. Demographics are not what they used to be; it’s much different. The numbers are increasing. Climate change is upon us, and there’s a global consensus that we need to do certain things differently. So it’s going to take a significant amount of investment. Technological changes are also happening.
On the other side of the equation are the productivity challenges we face in this country. That’s not new one — it didn’t start yesterday; it’s been with us for at least decades. But it’s not universal across all sectors. This distinction needs to be made.
The bank invested significantly in new technology, constantly doing things that you would expect of them. The auto industry is equally retooling constantly to ensure they can rebuild modern equipment. There are a lot of employers who have been laggard in investing in new machinery and equipment, despite generous tax benefits in the Income Tax Act to help them do so.
It’s one thing to say the government needs to fix the problem, but industry is taking no responsibility. We need to figure out how to prod this along, because our American friends are doing better than us statistically. We need to figure out this problem. Unless we can raise productivity, we face a significant challenge in the wealth we are going to create in the long term in this country.
I’m asking in a very honest way to recognize that it’s not universal across all sectors. The sectors have not been performing to the degree we expect them, and it’s really challenging.
The last point I’ll end on, in terms of the training front, workers have more skills and are more productive because you invest in training. If you look at our OECD numbers, they’ve consistently been bad. I don’t know what to tell Canadian employers, especially the ones who have been laggard. Get on with it.
Mr. Dodge: The issue of training has been with us since time immemorial. Employers in this country have traditionally done very poorly, and we’ve not been able to find ways to try to move that up.
There’s one issue that I think corporations are struggling with, and that is it seems that all the incentives for corporate management are to pay out retained earnings as opposed to investing in the future. The doctrine, if you will, of providing the incentive for managers to act in the interests of the shareholder to drive up the price of their stock, that being the measure that we reward managers with, means that there’s tremendous incentive on management’s part not to invest, but rather, to pay out.
If you go back in history, we did not allow corporations to buy back their own stock. There was a reason for that historically. We changed those rules, and I think the incentives that we give management at the moment really tend to operate against providing management incentive to invest in the research and planning that they have to do in order to build capacity in the future.
It is difficult how to structure that tax system, but I would argue we probably don’t have it structured right at the moment, at a time when we really need corporate management to make those investments. It tends to be founder firms and family-owned firms that actually do the right thing in that regard. To me, the incentive for the management of public corporations, doesn’t seem quite right at the moment.
Senator Wells: Thank you, Mr. Dodge, for coming here today.
In your opening remarks, you mentioned two things that caught my attention — the global trade orders and increase in investment in digital systems. I assume that would be for increased productivity. Can you expound on that, please?
Mr. Dodge: The global trade order changes are very unfavourable for us in Canada. We benefitted enormously in 1947 from the Havana Conference onward, in a world that was increasingly opening up and in which we increasingly, as a small country with some particular strengths and some general weaknesses, could benefit. That world started to change before COVID, and it’s changed dramatically since.
That just makes our life in Canada more difficult. I think we have to recognize that this is not a favourable global context. We have to try to continue to achieve open markets globally, but we are going to be struggling. It means that we’re going to have to invest more in domestic production to deal with the supply chain issues, and unfortunately, that investment often, at least at a global level, doesn’t increase efficiency at all.
That is a real struggle, but it’s not something that Canadians or their governments can actually do a lot about. We’ll struggle to do it, but we are a small economy that benefits from an open trading order. When that trading order fractures, then we struggle. And I think “struggle” is the right word.
Senator Wells: I think we’re there now. I know you’ve talked for the last couple of years about increased investment in digital systems and increased productivity.
Mr. Dodge: I think that’s right. We’ve been slow in this country in making those investments. We were slow in the 1990s with investing in Information Technology and Communications, or ITC, in this country. The big difference between the U.S. and Canada, if you look at the period, say, between 1995 and 2008, was the Americans had big productivity gains because they had made big investments in ITC, which we did not. This isn’t quite the same as the ITC we were talking about at the end of the 1980s and in the 1990s, but nevertheless, it’s the same issue.
Unless we make those investments in capital equipment — but more importantly, in the intellectual equipment and the IP that goes along with that — then we will fall behind again, in relative terms, the Americans who simply consecrate a much bigger fraction of corporate earnings to that investment, basically 4% there versus 2% here. It’s that investment that I think will yield the productivity gains that we hope for.
Senator Wells: Thank you very much.
The Chair: You will not be surprised that I’m going to come back to the trade question, given the part of the world that I represent. The impact of our diplomatic crisis now under way with India is substantial in my part of the world and right across this country. Could you comment on that and what we do about it?
Mr. Dodge: I’m not sure that I can be much help, senator. I would say that the basic strategy I thought we had, which was to put a lot more emphasis on the part of the world that we know is going to grow rapidly — the Asia-Pacific world — to put a lot more emphasis on what we do there than we have been doing. That strategy, to me, seemed to be absolutely sensible. In fact, there’s probably no alternative strategy that makes sense. But then we have to execute.
There are a lot of problems. There’s always glue you can put your foot in, as you try to execute on that, but we seem to have put our foot in the glue, and we’re going to have to go back and somehow repair that. Because there really is no alternative other than to ensure that our companies have markets in the fast-growing part of the world, and, similarly, in terms of some types of equipment that we have access to the lower-cost supplies that we can get from that part of the world.
We had the right strategy; we’re having trouble with execution.
The Chair: To risk understatement.
We will do a quick second round here, so I’m just going to ask people to keep preambles brief, please.
Senator Gignac: As you point out, Canada has benefitted a lot since the Second World War with globalization, but now the world has changed. I tried to identify if we have a tool in our tool kit that we have not used yet but could be available to explain the role of pension funds in Canada.
The public pension fund goes with the Maple Eight: 20 years ago it was around 5% or 6% of global savings in Canada. Now, it’s close to 20% of savings. These players, except Caisse de dépôt et placement du Québec, have a dual mandate. The others invest abroad, much less in Canada.
We have climate change, and we have a digital challenge. Some suggest that Canadian pension funds are very low profile of investing in venture capital and these kinds of things. Is it something that we have to revisit and maybe ask PSP Investments or the Canada Pension Plan Investments Board, also known as CPPIB, to have a dual mandate like Caisse de dépôt?
Mr. Dodge: The first job of a pension fund is to pay the pensions. Then you question, is the management that we have at the CPPIB or at some of the other big funds — the teachers’ fund or whatever — are they making the right judgments in that regard by having so little held in Canadian public equity? I mean, it’s almost a derisory fraction.
It seems very strange that those funds, who, in the end, have to pay their pensions in Canadian dollars to Canadians, that the balance of risk is so tilted toward only holding foreign public equities.
Senator Gignac: Yes.
Mr. Dodge: I think one can question, just on straight risk-management grounds, whether the allocation that the managers have chosen, over the long haul, make sense. That doesn’t require a change in the mandate at all, but it does require some hard thinking about the risk profile that they have.
I don’t think you have to go to an explicit mandate to invest at home, so to speak, but I think the risk aspect will tell you that, given who their beneficiaries are and what they have to do, that they ought to be holding a higher fraction of Canadian equity investments.
I’m not answering your question almost deliberately, because I don’t know the answer to the question.
Senator Gignac: We could invite them to come here to explain. Thank you for your answer.
Mr. Dodge: Yes, exactly.
[Translation]
Senator Bellemare: Mr. Dodge, do you know how other countries deal with the negative impacts of rising mortgage rates on households? Are there ways to protect middle-class households against rising rates? There is taxation, of course, but what other alternatives are there?
[English]
Mr. Dodge: The structure of housing in different countries is really quite different, so I think it’s hard to answer that. The very question that you’re asking, they’re asking Governor Bailey in the United Kingdom and they’re asking the Chair of the Federal Reserve in the United States. I’m not sure that there is a simple answer to it.
We adopted, in this country — and I understand exactly why — the view that housing was a consumer good, and for that reason, we don’t allow interest to be deducted. Similarly, we don’t tax capital gain. That was the approach we have taken. It’s a totally consistent approach. We may not always like it, but it’s a totally consistent approach.
To allow interest to be deducted, as the Americans do, and, at the same time, find all sorts of ways never to tax the capital gain doesn’t seem to be a very sensible proposition. It’s one where it creates an enormous bias to put savings into housing rather than into productive investment.
Senator, I don’t know anybody around the world that, in a sense, has the right answer. And in many European countries, of course, most of the housing is owned by landlords, and people rent rather than own. We have a very different mix here.
It’s hard, I think, to draw those lessons, but you should ask others who may know a lot more about it.
The Chair: We will. You can rest assured.
Senator Loffreda: Mr. Dodge, you did mention we need greater investment in domestic production. What policies or what recommendations would you put forward to incentivize our entrepreneurs to invest in Canada?
If we look at some of those numbers, is it just taxation rates? I look at some of the numbers — and, just quickly, while you think about the answers — Canada’s population is greying. Only 9% of business owners have a written succession plan in place. And if we look at the share of younger Canadians, aged 35 to 44, seeking to be their own boss, which has fallen from 3.3% in 1998 to 2% today. Especially in technology. You need young entrepreneurs. You need start-ups. We have to invest in technology.
Where are we going wrong? What could we do better? What policy recommendations would you put forward?
Mr. Dodge: Government cannot cure every ill, and to the extent that we are not making some of those investments in R&D — our private industry is not — it’s difficult.
I’m on the board of a start-up, and every nickel we have, we plow back into the firm. The Scientific Research and Experimental Development, or SR&ED, tax incentive is incredibly valuable to a little technical start-up, so at least that’s right.
We don’t think we’ll be in a position to actually pay taxes for a long time, as we reinvest every nickel that we earn.
That incentive that we do offer — I can attest — is actually a very useful one.
I guess I’m not so pessimistic about the young entrepreneurs. My observation is that the people who graduated from university in the last decade are much more inclined to go with a small firm and take a risk than they were 25 years ago when I was last teaching. I’m not so pessimistic. I observe these young founders, and they are a pretty aggressive and interesting group of folks.
The Chair: We heard a lot of testimony, Mr. Dodge, in preparation for our last report that the government programs are all kind of focused at the front end. There is help for the start-up; there isn’t help for the next phases. So they end up selling at an early point as opposed to growing.
Mr. Dodge: I think that’s right, but only in part for that reason. The other reason — and this has been historic in Canada — is that we have had very few firms where the drive was to be number one in the world. There seems to be a bit of cultural difference in that sense between Canada and the United States, and that is not new.
The Chair: We have heard testimony to that effect, as well, regarding that mindset.
Senator Wells: Mr. Dodge, what other tools besides the interest rate — which I know is a tool of the bank — does the government have to slow inflation? Would that include slowing spending that doesn’t contribute to productivity as represented by GDP or other metrics?
Mr. Dodge: The budget balance is the classic tool to affect aggregate demand. When we demand efficiency, we run deficits. When we start to get inflation pressures, the classic thing is to run surpluses. That is the budget balance.
The issue, as we look forward, is that given the amount of past debt that we have, the ability to use that budget balance if we run into another COVID or bad experience — we don’t have the room to use that for stabilization purposes that we had before. When things are going at least moderately well, we really need to be trying to rebuild a little bit of a cushion so that we can deal with bad things when they happen.
That’s the budget balance.
All the other tools the government has that affect the distribution across industries and income distribution up and down the scale, those are the real tools that government has to try to shape this rather than simply using the budget balance.
So allocation and distribution are not part of the stabilization function that the Department of Finance or the Bank of Canada has, and it’s those tools that are so important in creating the climate for industry to invest.
Senator Wells: Would it be safe to say that we overextended ourselves as a country during times when rates were low by having a budget out of balance?
Mr. Dodge: Actually, when rates were low, we went through a fairly restrictive period policy right after the great financial crisis. We have had both restrictive policy and expansionary policy in the pre-COVID era.
The year 2020 was a shock. We dealt with it. We didn’t know what was going to happen. We threw everything we had at it to try to deal with it. We were absolutely stunned by how quickly the recovery occurred in the fourth quarter of 2020. None of us in the summer of 2020 thought that we would have a recovery of that order of magnitude.
I think governments and the bank did exactly what they did, given the uncertainty of March 2020 and dealing with it.
One can look differently at whether the budget of 2021 made sense in that regard, but I don’t think, given all the uncertainties that we really ought to criticize what we did during 2020, scared as we were.
The Chair: Thank you for that.
Senator Galvez: I agree completely when you said that picking up the pieces is much more expensive than having a precautionary approach in identifying the disruptors. But I also see a lot of opportunities. As you said, the world is changing. In Europe, they have a green new deal and the U.S. has a few big bills.
We have access to a low-carbon economy, the care economy, the digitization economy — all in a circular economy that can provide more that we are all wanting: more economy and stability.
According to you, what are the clear signals that the government can change? You just said that the government has more tools than the bank to send clear signals to say that this is a stable economy, so come invest either the pension plans or international income and develop what they can develop here.
Mr. Dodge: You know better than me because you spend time talking to industry, but my strong sense is that part of our problem is that we actually create uncertainty in our policies. It’s not that a tough policy — a clear policy — is necessarily going to hurt investment at all, but what does hurt investment is when things are unclear as to where the government is going. We do seem not to have had a great record of being consistent in giving business a degree of certainty about the environment in which they are going to be operating.
We have to recognize that such is important. It means, quite often, that we can’t be too ambitious about having fine-tuned tools to do things. Getting things roughly right is probably a lot better than getting them precisely wrong in a number of circumstances.
The Chair: Thank you.
Senator Yussuff: Mr. Dodge, I know there is a simmering issue in the country right now that troubles me and everybody in the same way. The government of Alberta, certainly, has made an announcement that they are looking at — they haven’t made the decision yet about taking their assets out of the Canada Pension Plan. As you know, it is probably the most stable pension plan in the world. It has exportable premiums, it is indexed to inflation, and what have you. It has served the greater interests of the country since we created it.
Maybe you want to weigh in. From my perspective, recognizing the value of this for employers and workers in the broader sense but also with an increasingly aging population, what would be the value of disrupting something that seems to be working relatively well for the country, employer and, most important, for the greater good of the country? We don’t live in the same place all the time. Look at Alberta’s population over the last 50 years. It’s changed dramatically because Canadians have been able to move there and, similarly, have been able to move to other places.
Mr. Dodge: The changes we made in the CPP in 1997 put us in a world-leading position, and that plan is, arguably, the best and the best approach that there is in the world.
One starts with a very basic proposition that the more people you can spread the risk over, the better you are; and so the bigger the plan, the more likely you are to deliver the best returns for the population. The smaller you get you don’t have the management resources at the plan to do that work, number one; and number two, you end up with much more risk. The smaller the insured population, the bigger the risk. So that is a basic proposition before you go any further.
To me, I can’t understand why it would make sense. It would only make sense, in some sense, in a very short run because you could dream up a population structure in the future that might look as if you are going to benefit the current workers, but you know that 30 years from now, it won’t, right? You absolutely know you won’t. So, yes, you can get a little bit now, maybe, in terms of saving contributions, but you end up with a big problem down the road. That’s number one.
Number two, to try to justify this, you dream up some cockamamie rule to allocate the existing assets and the idea that they have on the table about the distribution of the assets were they to split a plan out. Remember, when we drew up the changes in 1997, we said at that time the provinces could withdraw — it’s not that it’s against the rule that we set up in 1997 — but it just makes no sense. And what they are proposing in terms of withdrawal of assets makes absolutely no sense, and it’s only if you have this very distorted reduction of assets that it makes any sense. Indeed, if you apply their rule and say everybody could withdraw, you would withdraw about 170% of the assets in the fund. It doesn’t make any sense.
Senator Ringuette: I’m trying to reconcile both of your statements. I agree on the fact that Canadian public corporations tend to give more to their shareholders than invest in the future of the corporation, on the one hand, and trying to get them to keep more in reserve and make that investment. Then the other scenario is about trying to get the public pension funds of Canada to invest more in Canada. How can we reconcile these two differences?
Mr. Dodge: That’s an excellent question. First of all, I hope I was clear. It’s the incentives we give management in the public corporations to do the under-investing. That is the way financial markets have evolved to assess what is going on. Management responds to that assessment; so their salaries go up with the current stock price. With the current stock prices, not future. That is that set of issues. The manager of the CPP or the CPPIB or one of the funds basically have to look at how well management of the companies they are investing in actually — is management taking the longer-run view, because for the CPPIB it’s the long run that matters. Those are the folks that need to have their pension protected.
I don’t think that there is a conflict here, but in assessing which companies to invest in as a fund manager, the pension fund should have a different way to assess risks than the ordinary private investment fund that sell their services to you and me. The nature of the returns that you are looking for in a pension fund is different than what you and I want. We want things to happen tomorrow, right?
Senator Ringuette: That’s the reconciliation that I’m trying to —
Mr. Dodge: Right. Clearly, then, it’s a matter of picking and choosing what firms or what stocks that you are going to invest in, or what private equity you are going to invest in. Private equity often doesn’t have the right incentive for a pension manager because the private equity firm’s incentive is to sell and get the return.
This is why I responded in the way I did to Senator Gignac. I think the whole question of the risk assessment issue would say, then, indeed, there are good reasons to put more into Canadian equity and, in particular, into those firms that have demonstrated the long-run capacity to reinvest and generate long-run earnings. That’s kind of where I come out on this.
The Canadian pension system, while not perfect, is, I would argue, close to being one of the best in the world.
The Chair: I just want to return to the housing issue because that’s what our committee is focusing on, for the next little while. You have talked about the aging population, and in response to that, the country has increased planned immigration and the number of refugees, but we have also seen a huge increase in the untracked and illegal migration of people. Given the crisis state we’re in, does there need to be some response to that?
Mr. Dodge: The answer is yes. It goes back to the productivity issue we were discussing earlier.
The only way you can increase people’s income is if you raise the productivity, on average, of the individual workers out there. That means that we need to be focusing on those areas of the economy where the productivity is high, and we need to be focusing on doing those things that raise the average productivity of the workers we have.
To the extent that we import people who bring skills and productivity capacity from abroad to work here, which is significantly greater than that of our existing workforce, then at least, on average, we are raising the average productivity of the economy. But to the extent that we simply import people, either temporarily or permanently, and redeploy them in industries or in occupations that generate an average output of considerably less than that of the existing population, then indeed, we are driving down productivity, on average.
The Chair: But it’s also the crunch in the housing sector.
Mr. Dodge: Well, yes, that’s absolutely true. I think that speaks to the speed at which you can make an adjustment. Making an adjustment very rapidly in the numbers creates a problem in and of itself.
I think it’s better to think about what it is that we are trying to do. I think what we are trying to do through our immigration policies is to raise the average productivity to attract skills, and that was the system that Mr. Marchand put in place in 1966 and that we basically followed for many years. We seem to have fallen off this and we keep chasing our tails to fill every employment gap, even when that employment is very low-productivity employment.
There are two issues. One is the speed at which we are changing. Secondly, it’s the structure of whom it is that we are trying to attract and why we are trying to attract them. It’s very important to remember that that is the key thing.
I’ll make one final point, senator. I think what is amazing insofar as I understand the data — and here I’m going to be careful because I may not have interpreted it right. My interpretation of the data is that with H-1B immigrants to the U.S., their average productivity is considerably above the domestic labour force. Permanent resident immigration to Canada is actually below, and to me, that is the real problem.
The Chair: It’s a very interesting point. I think we’ll look into that.
Senator Loffreda: We have elevated household indebtedness and stability in the financial sector — we always have a strong financial sector. Any concerns there? Any response to the increased household indebtedness that you would recommend? What are your thoughts on possible future increases to interest rates, given the household indebtedness?
Mr. Dodge: Absolutely. Very simply, the impact of an increase in interest rates in Canada, in particular as it applies to mortgage rates, is simply bigger than it is in the United States, I think we just have to recognize that. The peak level, if you will, in this cycle in Canada will probably be less and should be less than the United States. Unfortunately, that also means a weaker Canadian dollar, which doesn’t help on the inflation front either, but I think that is absolutely the case.
Looking forward, it probably means that, whatever neutral is in the United States is on a trend basis, we are probably going to be a little bit lower in Canada because of the very heavy indebtedness of our household sector.
The Chair: Mr. Dodge, thank you very much. This has been a marathon session, and you have taken all questions with depth and insight. Thank you very much for that.
We are going to suspend briefly. We’re going to have a two-minute in camera meeting here just so everybody is clear on where we’re headed on agenda, but we will wrap this meeting up formally and go in camera.
(The committee continued in camera.)