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  • OPINION – Is Canada facing its Pearl Harbour?

    Posted on: March 12th, 2017

    By Theo van de Kletersteeg

    I came to Canada in 1967, a year of momentous importance to Canada which, at the time, celebrated its 100th Anniversary, and welcomed the world through Expo ’67. As a young immigrant from Holland, Canada seemed to be a dream come true. I found a well-paying job one day after arrival in Montreal, and the money I earned was sufficient to pay my rent, buy groceries, and enjoy wonderful evenings and weekends at Expo ’67. Life was good. Eager to learn about Canada, its system of government and its economy, things got even better as I learned that “Canada Inc” was well financed, with very low budget deficits, and negligible debt. Practically speaking, unemployment did not exist, and neither did inflation. In my first few years in Montreal, it was not uncommon for me to receive annual pay increases of 10 per cent or more which, because of stable income taxes and near-zero inflation, amounted to sizeable increases in spending power. Unfortunately, the good times did not last and by the early seventies it became evident that things were becoming more difficult.

    Fast forward to 2017: an awful lot has changed. Some things for the better, but not many. Canada is clearly struggling, and has actually been struggling for decades. Jobs are difficult to find in general, and many entry level jobs require a University degree. Pay increases? Just be happy to have a job at all. Income disparity has grown a lot, as has poverty. Where I shop, you can read it in people’s faces. With industrial jobs dwindled from previous numbers, many more families are finding it hard to put food on the table.

    What has happened to the country? I am not sure. On the one hand, the sixties were good all over the western world, and Canada participated in the good times. Moreover, as a country whose economy was largely built on export of commodities, the sixties were years when there was strong growth of capacity-building, both in resource industries as well as in general industry. However, in 1959 an important development took place whose impacts we arguably still feel today. The Diefenbaker government, under pressure from the U.S. government, withdrew its backing of Toronto-based A.V. Roe’s (better known as Avro’s) Arrow fighter intercepter which, at the time, and for decades to follow, was hailed as a world-class aircraft. With Canadair not engaged in any major programs at the time, there were no alternative Canadian aerospace firms to work for, resulting in thousands of engineers and others leaving Canada to work for Boeing, Lockheed, Grumman, NASA and other U.S. defence and aerospace organizations. It was a huge blow to Canada’s industrial development which, at the time seemed to be “manageable” because the economy exhibited strong growth in other areas. However, since the seventies, there have been numerous calls for Canada to develop a more diversified economy, one less reliant on resource exploitation. That never happened, partly because Canada had abandoned its highly successful efforts to create a Defence industry to compete with U.S. industry participants.

    In subsequent years, it became evident that it would be very difficult to change the mentality of Canadian business owners. Numerous Canadian companies had been established behind the protection of tariff walls, which had made Canadian businessmen complacent, having become comfortable selling to domestic customers. Later, as tariffs were abolished, many Canadian companies intensified their marketing efforts to sell to U.S. customers, but few ventured overseas to seek new markets.

    In more recent years, global competition intensified, which meant that numerous Canadian companies that had not invested in new technologies could no longer compete against imported products, and closed their doors. This development started in the seventies when, for example, the Canadian textile industry was obliterated by foreign competition. Another wave of industry consolidation followed after the NAFTA trade agreement was put in place, causing many foreign-owned companies to question why they should maintain their presence in Canada, when Canadian customers could just as easily be serviced from other corporate facilities in the U.S. Finally, in the nineties, the rise of China’s export machine destroyed many of Canada’s remaining Canadian manufacturers, and caused renewed consolidation of facilities owned by multi-plant operators. Canada’s auto industry suffered, as did its steel industry. To readers of Canadian Sailings, perhaps more telling than anything else is that while the St. Lawrence Seaway reached 100 per cent of operating capacity two years after its inauguration in 1959, during the past decade it has struggled to operate at 50 per cent capacity. The economy has changed, and many once-mighty rustbelt industries have disappeared.

    Somewhere along the path of restructuring Canadian industry, we lost our one and only truly multinational corporation, Nortel Networks, to intense foreign competition and a made-in-Canada accounting scandal. As if that was not enough, Blackberry succumbed to the forces of international competition, and is in the process of being re-engineered as a company focused on world-class software development. Our auto assembly plants, little more than foreign-owned branch plant operations, but major employers in Ontario, have suffered from competition from southern states and Mexico, and are at risk.

    Since the election of the Trudeau government in 2015, many new government workers have been hired, payroll taxes have increased, many provinces have implemented higher minimum wages, and carbon taxes have been imposed. In addition, more than 50,000 refugees have been admitted, and many thousands more are to be admitted in 2017, creating a significant financial burden on the country, now and well into the future. In addition, while Mr. Trudeau was elected partly on the basis of promising responsible fiscal management, Canada is now facing federal budget deficits in the order of $20 billion, for the current fiscal year, and the next few years. Oil prices, although recovered from 2015 and 2016 lows, are hovering around US$55/barrel, a price that is below what the industry needs to once again become a dynamic, job-creating industry.

    Sunny Days are definitely fewer and fewer. However, as if these threats to Canada’s prosperity are not enough, a reform-oriented President has now been inaugurated in the United States, and he has wasted little time throwing out the old, and bringing in the new. The new President has mused about numerous measures he might implement to revitalize an American economy that has stagnated, and is no longer capable of fulfilling the “American dream” to the majority of its citizens.

    While Mr. Trump has chosen to remain vague about many elements of his economic recovery proposals, several principles are clear. His overarching idea is to make it attractive for American and foreign-owned companies to expand and/or establish operations in the U.S., thus increasing employment opportunities for Americans. Chief among his proposals are significant reductions to corporate and personal tax rates which are intended to stimulate investment in the U.S., partly through the repatriation of billions of dollars of holdings of U.S. companies abroad. Another key component of the planned reforms is the substitution of border taxes to compensate for the expected reductions of income tax revenue. These reforms would be devastating to Canada, from several points of view: The proposed slashing of U.S. corporate income taxes, in combination with other contemplated measures would create a giant magnet in the U.S. for anyone doing business in the U.S. from a non-U.S. location. With 75 per cent of Canada’s exports ending up in the U.S., the “magnet” will seduce many Canadian corporations to look into leaving Canada, or to expand operations in the U.S. Furthermore, while many foreign corporations have in the past chosen to set up shop in Canada to service customers both in Canada and the U.S., the current uncertainty about the future of NAFTA, and the impending U.S. income tax reforms will cause many foreign investors to move to the U.S. instead.

    These are only the tip of the iceberg. There are a lot of other friction points that have the potential of creating poor outcomes for Canada. One is Canada’s immigration policy, which is at odds with U.S. policies – is this going to ultimately reflect itself in less fluid border crossings for Canadian citizens and permanent residents who need to go to the U.S. periodically for their employers? If yes, this could be a further incentive for Canadian companies to move. There is even the possibility that proposed legalization of marijuana in Canada might cause our borders to “thicken”, a frightening prospect for businesses that rely on the free cross-border movement of people and goods.

    Another friction point is Defence spending. For quite some time, Canada’s defence spending has been at the bottom or near the bottom of defence spending as a percentage of Gross Domestic Product (GDP) of all NATO countries. Canada spends just less than 1 per cent of GDP on defence, and the U.S. has advised all NATO nations that it expects all member nations to increase spending to 2 per cent of GDP. In the case of Canada, that would mean additional annual expenditures of some $20 billion. Even if implemented over a multi-year period of time, where would the money come from?

    Business regulation is another area where Canada will need to make significant changes. Mr. Trump has announced that for every regulation implemented, he wants to see two abolished. In Canada we have suffered from serious over-regulation, as a result of which little gets done. Witness the time it has taken to get some pipeline projects approved while others are left hanging in limbo. Some ten years ago, Australia and Canada both started talking about creating massive LNG industries, to export liquefied natural gas to Asian countries that are not well-endowed with energy resources. It is now estimated that by 2020 Australia will be the number one global LNG exporter while in Canada not a single plant is even under construction.

    Let’s talk about government finances. During the year ended March 31, 2016, the federal government took in revenues of $295 billion. Of that revenue, half came from personal income taxes, 14 per cent from corporate income taxes, 19 per cent from EI premiums and GST collections, and the remainder (17 per cent) was derived from other revenues, duties and taxes.

    More than a quarter of the funds collected (28 per cent) were spent on transfers to individuals, mostly elderly benefits, EI benefits and children’s benefits. Another 22.2 per cent of funds collected were transferred to the provinces, mostly in support of provincial healthcare and education expenses. Operating expenses of government departments amounted to 17 per cent of government expenditures, and National Defence weighed in at 9.7 per cent. Interest payments on the national debt amounted to 8.6 per cent. The remainder (14.5 per cent) represented transfers to Crown Corporations and transfer payments to aboriginal peoples, farmers, students and businesses, support for research and development, and foreign aid and international assistance. In fiscal 2016, the federal government spent $1 billion more than it took in, and things are about to get a lot worse.

    Next, let’s take a look at Canada’s debt. The official number as at March 31, 2016 stood at $616 billion. However, that reflects an accounting definition. If we ignore the value of building and other physical assets and investments the government owns, and if we ignore receivables and payables in the ordinary course of business, there is long term debt of $688.2 billion, plus $237.9 billion of pension and other post-employment benefits owing to federal employees, minus $48.8 billion in cash, for a net balance of $877.3 billion.

    Although that number is relatively low by international standards, these debts have to be repaid, likely in less prosperous times, when it is that much more difficult to find the cash to meet one’s obligations. We should also not forget that while the national debt appears to be manageable, given Canada’s GDP of about $2 trillion dollars, our real debt is the sum of federal, provincial, territorial and municipal debt. After all, there is only one gross domestic product which is the source from which all transactional obligations and long term debt obligations are to be met. There is only one set of taxpayers that collectively needs to repay all public debt, regardless of how many ways we slice that debt. As it turns out, our present cumulative provincial debts amount to approximately $758 billion.

    Although I did not delve into debt owed by municipalities, I have no doubt that number is well in excess of $100 billion. Furthermore, the Toronto Sun of April 12, 2014 estimated that Canada’s unfunded liabilities for pensions (CPP, OAS) and healthcare amount to $2.2 trillion. So, let’s quickly forget about the $616 billion referred to as Canada’s public debt. The real number is more like $4 trillion, about twice the size of Canada’s GDP.

    If that isn’t scary enough, consider that with household debts of $1.9 trillion (more than 160 per cent of disposable income), the ability of Mr. and Ms. Taxpayer to pay ever-increasing taxes has become quite limited.

    So here we are, drowning in debt, at all levels, and facing ever-greater deficits at all levels of government. Moreover, who knows what Mr. Trump has in store for us, and how his actions will impact our economy. One thing is for sure: very few, if any of his economic policies will be good for Canada. Strangely, until recently, Canadian stock markets were setting new records on a daily basis.

    What I cannot understand is how complacent Canadian economists, business commentators, and securities analysts are in taking the new threats seriously. Can they not see that Canada has steadily lost international competitiveness over the decades? Can they not see that, increasingly, Canada Inc. is becoming a higher-cost jurisdiction, as a result of a lot of “entitlement” programmes focused on more and more people who are not contributing to the economy in a positive way? Can they not see that economic developments in the U.S., while positive in the U.S., will inevitably have a negative impact on the Canadian economy?

    Some of the largest Canadian companies in the energy industry are in the process of finalizing business acquisitions in the U.S. that will allow these companies to virtually double in size. In the past, I would have viewed these acquisitions as very positive for Canada, but in the present context I am wondering how many of these companies will ultimately see their U.S. operations as their core activities in a more business-friendly nation, and will move to the U.S., in much the same way that Restaurant Brands International (the parent company of Tim Hortons and Burger King) moved its corporate Head Office to Canada after having acquired Tim Hortons.

    We do not have any details of any U.S. Administration plans available at this time, so all we can do for now is speculate. However, there can be little doubt that Mr. Trump intends to follow through on his economic reform agenda. Given the financial circumstances of Canadian governments at all levels, and given that our already feeble economy is hardly capable of dealing with further major setbacks, how is Canada going to deal with the consequences of tax and regulatory reform in the U.S.? I consider the possible consequences a “Pearl Harbour” moment. Pearl Harbour, Hawaii, was the place where the U.S. Pacific Fleet was anchored in December of 1941, and which became the subject of a massive surprise attack by Japanese forces that put all eight American (Pacific Fleet) battleships out of commission, and destroyed numerous other Navy assets. The U.S. had considered Hawaii a safe place to station its Pacific Fleet, only to be proven wrong. In Canada, we presently consider revitalization of the U.S. economy as positive for Canada. Could it be, however, that we are wrong in our assessment, and that increased prosperity in the U.S. is in reality a stealthy development that may begin to deprive Canada of its most entrepreneurial corporations and businesspeople as cancellation of Avro Arrow’s project did in 1959?

    Of prime concern is Canada’s auto industry. The assembly plants, together with their numerous domestic suppliers, are the largest industry in Ontario, a province that was once a major engine of growth for Canada, but is now a struggling “have-not” province. What would Canada and Ontario do if the auto industry were threatened? While the auto industry may be the biggest target, there are plenty of other targets which, collectively, would be just as important. Does Canada have a plan to deal with the fallout of a changed U.S. business environment? No, Canada does not have such a plan.

    From my lengthy observation of this economy, my “recipe” for positive change in the nation’s economy is based on a shift from a government-driven to an entrepreneur-driven economy. We have far too many government workers and too few people who are challenged by taking risks. This is partly a cultural challenge, as taking risks is not a strong part of the DNA of Canadians. Yet, I have seen sufficient evidence in my business career to know that there are entrepreneurs out there with the motivation and perseverance to build world-class enterprises based on innovation and creativity. These entrepreneurs need to be encouraged, financially and otherwise, and need to be coached through professional management assistance. There needs to be a new “can-do” attitude in Canada, where it is now fashionable to be an obstructionist or naysayer. For starters, it is my suggestion that our government should convene a panel of accomplished business leaders, international management consultants and investment bankers to determine Canada’s strengths and weaknesses, and to create a business plan together with rolling out an implementation plan, to strengthen existing winners and to create new enterprises to successfully do battle in a far more competitive global economy. If seen fit, our financial institutions should be allowed to merge and should be encouraged to become global enterprises. On the other hand, international banks should be allowed to operate and compete for retail and business banking clients in Canada like Canadian banks. Similarly, other protected federally regulated industries such as railways, airlines and telecoms should be deregulated, allowing them to compete internationally, but also be subject to international competition in domestic markets.

    It is my opinion that without a plan to invigorate Canada’s economy, our prospects are bleak. In the past twenty years we have lost several hundreds of thousands of jobs to import competition, automation and plant consolidations. While Mr. Trump’s economic plans for America represent an immediate threat for Canada, lagging productivity in Canada and increasing costs will do nothing to make us more competitive internationally. Furthermore, ongoing advances in automation will cause hundreds of thousands more to lose their jobs in years to come. How long will it be before truckdrivers and other drivers of industrial and commercial vehicles will be out of a job? And what will those people do to re-enter the workforce? We are about fifty years late in anticipating the future and figuring out what we should do today to meet tomorrow’s challenges. But, it’s better to start late than never.

    For fifty years Canadians have talked about creating a diversified economy. But it was just talk. Instead, we created an economy based on maximizing consumption, maximizing entitlements, and deferring real problems for our children to deal with. Our focus was and is on consumption, rather than creation. Our debt levels have risen so high that we seriously need to question the sustainability of our economy if a major shock were to take place. To pull us back from the brink, we need to make substantial reductions to the cost of government, and we need to create a “business plan” to help create a stronger and more diversified economy that will provide meaningful full-time job opportunities for all who wish to work.