Canada needs a productivity revolution

Boosting Canada’s growth in the longer term requires a revolution to address productivity, says CIBC chief economist Avery Shenfeld.

Currently, “we’re still on a fairly lacklustre track in terms of Canadian economic growth,” Shenfeld said in a recent interview.

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Real gross domestic product (GDP) grew 0.3% in April after remaining essentially unchanged a month earlier, and an early reading for May suggests the economy may have slowed to 0.1% for the month (data for May will be released on July 31).

Shenfeld, referencing Canada’s strong population growth over the past year and a half, said growth in economic output is weak in per capita terms.

This issue is reflected in the rising unemployment rate, he said, and, while “we might see the jobless rate level off, we’re probably not yet going to see the kind of pickup that would bring us back to the lower unemployment rate we had a year ago.”

The unemployment rate increased 0.2 percentage points to 6.4% in June and has risen 1.3 percentage points since April 2023, based on StatsCan data.

The good news for Canada, Shenfeld said, can be found in the inflation rate, excluding mortgage interest costs.

“If you remove that one item, inflation actually has been running roughly in line with the Bank of Canada’s 2% target over the past year,” he said.

That’s a key reason why the central bank is comfortable with beginning to cut interest rates: “As that happens, and those mortgage interest costs actually decelerate, the overall headline inflation number will also return to that 2% target,” Shenfeld said.

Canada’s slow economic growth calls for “a substantial dose” of interest rate relief, he said. If June’s inflation numbers are contained, “the Bank of Canada will have the green light to cut in July.” Inflation data for June will be released later today.

Regardless, it’s not the timing of cuts that matters but “the prospect that a year from now, interest rates will be low enough to get the economy moving again,” Shenfeld said.

Still, he highlighted broader economic challenges, such as the need for improvements in productivity to enhance living standards and economic output per capita. He also said insufficient business capital investment and lagging innovation in key sectors like technology are critical areas needing attention to boost productivity and match U.S. growth rates.

“We need more of a revolution … in terms of what we do in the Canadian economy,” he said.

The U.S. economy has shown resilience in the midst of rising interest rates, Shenfeld noted — even accelerating its growth in 2023.

However, signs of moderating growth are starting to appear south of the border, as the impact of higher interest rates is felt in some parts of the economy. For example, there are fewer job vacancies, and inflation is beginning to ease.

In the first quarter, the U.S. economy expanded at a 1.4% annual pace — the slowest quarterly growth since spring 2022.

“We are expecting to see a slowdown in the U.S. economy over the balance of 2024,” Shenfeld said.

Despite this, he was positive about the Federal Reserve’s ability to mitigate a severe economic downturn by potentially lowering rates a couple of times by year-end, which should set the stage for U.S. growth to gradually pick up over the course of 2025.

“The bottom line here is that the Federal Reserve is in a good position to protect the U.S. economy from a more serious downside,” he said.

For investors, slower economic growth in the next few quarters means slower earnings growth, which will weigh on equities.

On the other hand, with yields moving higher over the past couple of years, bonds have room to provide investors with returns.

“We do expect that a balanced portfolio offers some pretty good protection right now, in terms of what happens if the economy surprises to the downside,” Shenfeld said.

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