Economic Update (May 2001)
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Presentation 
by the Honourable Paul Martin, P.C., M.P. 
to the House of Commons Standing Committee on Finance

May 17, 2001

Delivered text is official version.

Introduction

Thank you, Mr. Chairman, and let me thank the committee for this opportunity to appear before you today.

In the months leading up to today’s Update, I have had the opportunity to participate in extensive discussions on the global economy with the G-7 and G-20 finance ministers, the International Monetary Fund and the World Bank; on the North American economy with members of the business community from both sides of the border; and on our economy with a group of key Canadian economists.

Most importantly, since January, I have travelled to every region of the country, meeting with Canadians, participating in informal consultations, town hall meetings and locally based roundtables. In one community after another, the participants were kind enough to share their ideas, their insights, their hopes and concerns, and I want to thank all of those who took the time to do so.

Sometimes, in analyzing data, it is easy to get caught up in the language of economists and statisticians, but we must never forget that while economic activity is reported in numbers, it is experienced in the lives of Canadian families. After all, the "the economy" is not some abstract concept – "out there," "somewhere," "some time." It is the fabric of everyday life; it is the plans people make, the confidence they have and the activities they enjoy.

So it is certainly understandable that when Canadians speak about the economy it is not in the language of rates and ratios. They speak of affording a home, buying groceries or planning their children’s education. They talk about their wish for a secure retirement and a health care system that’s there when they need it. They also speak of the need to direct the economic strength of our nation to improving the lives of our people. They tell us that economic growth must be aimed at a higher purpose. And that is why a balanced approach is as important as a balanced budget.

Most Canadians I met expressed their confidence in the overall direction of our economy but, naturally, they were concerned about how the current slowdown, which started in the U.S., will affect them and their families. Today I want to speak to those concerns. Specifically, I want to update Canadians on how the global changes that have taken place since last October’s Statement have affected our nation’s finances and our economic prospects, and to outline the measures we are taking to support growth.

International Economic Situation

Let me begin with the broader international picture.

For an open economy like Canada’s, with more than 40 per cent of our gross domestic product (GDP) generated by exports, what happens outside our borders has a direct impact on what happens inside.

At its meetings last month, the International Monetary Fund said that short-term prospects for global growth have weakened and, as a result, projections for growth were lowered from 4.2 per cent to 3.2 per cent for this year. In Europe the pace of economic activity has slowed and is below potential. In Japan, the world’s second largest economy, low consumer confidence and fundamental problems in the financial system continue to prevent a sustained recovery.

United States’ Economic Situation

In the United States – the economy that affects us most – the slowdown has turned out to be steeper than expected. The U.S. economy started last year growing at an annual rate of 5 per cent, but by the final quarter it was growing at just 1 per cent.

While preliminary estimates for the first quarter of this year show some improvement, the near-term outlook remains unclear. Indeed, the most recent labour force statistics, which showed a decline in U.S. employment, point to this uncertainty. Private sector economists are now projecting that growth in the U.S. will average 2 per cent in 2001. This reflects the widely held view that significantly lower interest rates will pave the way for renewed growth this year. We hope that proves to be the case. But we remain cautious and are taking nothing for granted.

Current State of the Canadian Economy

Clearly, the Canadian economy is feeling the effects of the weaker U.S. economy. Growth here in the final quarter of last year was considerably less than in the preceding quarter, primarily reflecting much slower activity in the automobile industry and in the information and communications technology sector. Both industries, which depend heavily on exports, have faced falling demand from the U.S. In response, both have had to cut back production to deal with excess inventories. These actions, in turn, have had their effect on the Canadian economy, postponing investment decisions and reducing near-term growth.

At the same time, however, there have been a number of encouraging developments which have helped to offset this weakness.

First, other export-oriented Canadian industries, such as aerospace and energy, have continued to grow at a strong pace. Service industries and construction – particularly the housing sector – which are domestically oriented, have also continued their solid performance. This strength in services, aerospace, energy and construction is important because together they produce more than 75 per cent of Canada’s total economic output.

Second, Canada’s external balance has improved substantially – from a deficit of $28 billion in 1993 to a surplus of $19 billion in 2000. This, in turn, has resulted in a sharp decline in our foreign indebtedness – from 44 per cent of GDP in 1993 to 23 per cent last year, its lowest level since the early 1950s. This decline in foreign indebtedness is significant. Reducing the amount of money that we pay to international creditors gives us greater flexibility to manage our own affairs and keep interest rates low. This is all the more welcome in today’s uncertain global environment.

Third, and most importantly, employment continues to grow and Canadians are beginning to see their disposable income rise again. This, combined with large tax cuts and lower interest rates, is supporting solid consumer spending this year.

Mr. Chairman, given the mixed signals on the health of the economy, it is not surprising that there are differing perceptions about its present state. What is important is to put these differing opinions into context. In summary, what is clear is that all of the available facts and figures show that, albeit at a slower pace than last year, the longest Canadian economic expansion since the 1960s – some 22 quarters of growth – is continuing.

Since taking office in 1993 we have consistently budgeted on a rolling two-year basis. Given the uncertainty inherent in long-term projections, this approach has served us well in the past and will do so again in the future. As part of this approach, the Department of Finance surveys some 19 private sector forecasters to obtain their best estimates of the economic outlook. Based on that survey, we then meet with the chief economists of Canada’s major chartered banks and four leading forecasting firms to make doubly sure that the average of private sector forecasts is a reasonable basis upon which to plan. This approach ensures that the assumptions we use are realistic and credible.

In preparation for this Update, we have again conducted this process. Mr. Chairman, looking ahead to the next two years, the economists have projected that while the deceleration in economic growth is sharper than previously anticipated, the economy will continue to expand. Where there is less agreement is on the extent of that growth. Indeed, the forecasts for 2001 range from a high of 2.8 per cent to a low of 1.6 per cent, with an average of 2.4 per cent. For next year, 2002, the economists expect a rebound, with forecasts ranging from growth of 2.5 per cent to 4 per cent, with an average of 3.4 per cent.

The question is: What do these forecasts mean for the finances of the nation? Specifically, what do they mean for our projections of balanced budgets? For the tax cuts promised in Budget 2000 and in the October Statement? For the Health Accord reached with the provinces and territories last year?

Let me begin by reminding you of the situation at the time of the October Statement and what we had projected for each of the next two years.

In October, after funding our tax cuts and expenditures such as the Health Accord, we projected a total surplus of $8.3 billion for 2001-2002. This was made up of $4.3 billion in unallocated surplus – to cover priorities such as those outlined in the Red Book – the $3-billion Contingency Reserve and $1 billion in economic prudence.

Based on the revised average of the private sector forecasts of 2.4-per-cent growth in 2001, offset by lower interest rates and the ongoing impact of higher-than-expected revenues last year, the budgetary balance will decline by $1.1 billion. This leaves a surplus for the current fiscal year of $7.2 billion for prudence, to cover our $3-billion Contingency Reserve and to deal with policy measures, of which $600 million has been committed to date.

For 2002-2003 we projected a total surplus of $7.6 billion. This was made up of $2.6 billion in unallocated surplus, the $3-billion Contingency Reserve and $2 billion in economic prudence. Using the revised average of the private sector forecasts of 3.4-per-cent growth for 2002, and again taking into account similar offsets, the budgetary balance will decline by $300 million. This leaves a surplus for 2002-2003 of $7.3 billion for prudence, the Contingency Reserve and policy measures, of which $400 million has been committed.

Mr. Chairman, let me go one step further. The aforementioned numbers are derived from the average of the total range of private sector forecasts. Let me now use the average of the most pessimistic of the private sector forecasts. Even here – 1.8-per-cent growth in 2001 and 2.9-per-cent growth in 2002 – the net impact would result in an adjusted budgetary surplus of $6.2 billion this year and $5.1 billion next year. In other words, Mr. Chairman, despite the economic slowdown, and even assuming the more pessimistic average private sector forecast, the Health Accord is protected; the $100 billion in tax cuts is protected. And we will not fall back into deficit. This is the payoff for the prudent approach we have adopted from the beginning.

In the past some have suggested that we were being overly cautious. However, we have never assumed that the business cycle had been abolished. We have always believed that it is better to prepare for rain, even in the sunniest of forecasts. Now that clouds have appeared, Canada has not been caught unprepared.

Mr. Chairman, that being said, while our fiscal situation allows us to ride out the current economic slowdown, we are very conscious of the reality that many Canadians are feeling its effects. It is of little comfort to them to hear that the Government is doing fine. They need to know that we have acted – and continue to act – in ways that will benefit them.

Actions Supporting the Canadian Economy

In the February 2000 budget and the October Statement, we outlined a number of actions which are part of our ongoing strategy to protect Canadians, a strategy to invest in the social fabric of our country, reduce taxes and pay down debt. These actions are not only the kind of initiatives that will contribute to the long-term strength of our economy – they also provide stimulus in the short term when we need it now, by putting more money into the hands of Canadians, by spurring business, sparking investment and creating jobs.

First and foremost, there are tax cuts – the largest in Canadian history.

Last October we reduced the tax on capital gains and increased the investment amount for tax-free rollovers. In January we took a second step in creating a new Canadian advantage for investment and job creation. We cut corporate income tax rates by one percentage point, and further cuts – two points in each of the next three years – will bring corporate rates below levels in the U.S. Because these corporate tax cuts are being fully legislated, businesses can – and should – factor them into their investment plans starting immediately.

In terms of personal income taxes, our actions have been even more dramatic. In January of this year we reduced taxes at all income levels – 21 per cent on average – putting more money into the hands of Canadians, especially moderate-income families with children. As well, the earlier reintroduction of indexation increased personal credits and tax brackets so that taxpayers will be forever protected from inflation. And finally, in July a further $900-million stimulus will come with the increase in the Canada Child Tax Benefit, bringing significant help to families with children.

What do all of these tax measures mean for Canadians?

A typical two-earner family of four with a combined income of $60,000 will see its federal taxes drop by $1,000 this year – an 18-per-cent tax cut. A single parent with one child and $25,000 in income is receiving an additional $800 this year, for a total benefit of $2,500. Mr. Chairman, this year alone these tax measures will provide the Canadian economy with $17 billion in added stimulus.

Furthermore, in addition to the tax reductions, which are largely focused on middle- and low-income earners, a number of strategic investments are being made in areas that are also of great importance to Canadians – areas like health care, education and innovation.

As mentioned earlier, last September the federal, provincial and territorial governments signed a five-year Health Accord, to which the Canadian government contributed $21.1 billion. This included $2.2 billion for early childhood development, which will help to ensure that our children get the best possible start in life, arriving at school ready to learn and equipped to succeed. This year, as a result of the Accord, the Canadian government will provide an additional $2.8 billion to the provinces and territories for health, education and children. In addition, $1 billion has just been provided to the provinces and territories to purchase medical equipment, along with $500 million for investments in health information technology and $200 million per year for each of the next four years for the Health Transition Fund, which supports innovation in primary health care reform.

A further $800 million in equalization payments will flow this year as a result of the lifting of the ceiling for 1999-2000. This is in addition to the recently announced $1-billion increase in equalization payments for 2000-2001.

Mr. Chairman, in Budget 2000, we announced a five-year program consisting of $2 billion for infrastructure, particularly in the area of the environment, and $600 million for highways. Because this funding will be provided on a cost-shared basis, it will leverage more than $6 billion for infrastructure and $1.2 billion for highways. These investments will benefit communities right across Canada. Agreements on the infrastructure portion have now been reached with all of the provinces and two of the three territories. As a result, we expect more than $1 billion in new capital investment this year alone.

One of the most consistent threads that has run through our policies in recent years has been a recognition that innovation is key both to the strength of our economy and to the quality of our lives. Budget 2000 and the October Statement built on that imperative, making large, long-term investments in the knowledge infrastructure of our country – our universities and research institutes. Thus, this year alone $500 million will be injected into the economy through the Canada Foundation for Innovation, Genome Canada and the Atlantic Investment Partnership.

Mr. Chairman, taken together, all of the expenditure initiatives announced in Budget 2000 and the October Statement amount to almost $7 billion in stimulus for the Canadian economy this fiscal year. When combined with the $17 billion in tax measures, the total impact this year alone will be close to $24 billion – this is one of the most, if not the most, stimulative packages introduced into its economy by any government of a major industrialized country this year.

Finally and very significantly, reinforcing these fiscal actions have been the steps taken by the Bank of Canada to lower interest rates. The Bank Rate has fallen by a full percentage point in the last four months alone, providing real relief to Canadian families. One-year mortgage rates, for example, have fallen significantly since last December. This means it is easier for young couples to buy that first home or for families to trade up to a larger one. It means cars and other major items are less expensive to finance and it means lower borrowing costs for those wanting to start or expand their businesses.

Mr. Chairman, so far I have talked about the state of the economy, the impact the current slowdown is having on our finances and some of the measures we are taking to stimulate growth. Looking ahead to the longer term and to the underlying fundamentals of our economy, let me now address two other issues.

First, the anchor of a low interest rate policy is the establishment of a low-inflation regime. The Bank of Canada and the federal government have achieved success in this respect through three-year agreements on inflation targets. The existing agreement is due to expire this year. To maintain low inflation, lower interest rates and continued growth, I am pleased to announce today that we have agreed with the Bank of Canada not only to extend the current agreement on inflation targets, but to do so for five years. That means our target range for inflation will remain between 1 per cent and 3 per cent. Maintaining these targets will allow markets and investors to plan with confidence, knowing that Canada will remain a low-inflation environment.

Second, in terms of the national debt, Canada has reduced its federal debt-to-GDP ratio from a peak of 71 per cent in 1995-1996 to below 53 per cent at the end of last year. In recent years no country has reduced this ratio as much as Canada. Furthermore, in absolute terms, we have paid down the federal debt at an unparalleled pace. When times are slow, the rate of debt reduction will naturally slow, but when times are good – as they were last year – we should take advantage of that fact to reduce the burden on future generations.

In the October Statement, the Government committed to paying down at least $10 billion of debt. Because our revenues were higher than expected, I am pleased to announce today that we will do better than that. We now expect to pay down at least $15 billion of debt for the year just ended. This means that we will have retired more than $33 billion of debt in the last four years – $27 billion in the last two years alone – saving Canadians close to $2 billion a year in interest payments – money that can be used for other priorities such as health care and education, year in and year out.

Conclusion

Mr. Chairman, let me just say in closing, that the global economy is slowing is clear. Our job is to enable Canadians to ride through the downturns and to take advantage of the upturns. Therefore, we will continue to report to Canadians on the trends. And let there be no doubt, we will remain vigilant.

However, there are those who say that to counter the slowdown now we should cut taxes more or that we should spend more. In other words, that we should take the chance of going back into deficit. Well, that we will not do. We will not put at risk all that Canadians have worked so hard to achieve over the past few years. Rather, we will maintain the approach that has seen us through the peso crisis of 1994 and the Asian crisis of 1997, and which will see us through the current slowdown.

Looking ahead, our long-term plan means we will continue to cut taxes, it means we will continue to cut debt and it means we will continue to control spending. But as well, it means we will never forget that in the knowledge economy, the real engine of growth is the human mind, and that how we equip our people today – to learn, to invent, to create – will determine this nation’s ability to produce jobs, to generate growth, raise living standards and provide opportunity tomorrow. For this reason, we must continue to invest in education and innovation. We must overcome the shortage of skilled workers across the economy and help those who have difficulty with the transition, never forgetting that the society we build is just as important as the economy we create.

That is why, Mr. Chairman, when challenges come, we must keep our eyes fixed on the purposes we have set and remind ourselves not only of what we have already done but, above all, of what we can do together.

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