Lack of Investment Slows Economy

My take on today’s second-quarter Gross Domestic Product (GDP) release follows:

Economy Shrinks, But Dodges Recession

Canada’s GDP was lower at the end of June ($1,327,118 million) than at the end of last year ($1,328,606 million). Although the Canadian economy is smaller now than it was two quarters ago, it is technically not in recession because it did not shrink in each of the two consecutive quarters. The decline came in the form of a downward revision to the first-quarter numbers, rather than as a drop in the second-quarter numbers.

It possible that second-quarter revisions will reveal that there was a recession, when they are released on December 1 along with the third-quarter figures. However, any such revelation would occur after a widely anticipated fall federal election.

The second-quarter figures show an increase only relative to the first-quarter decrease. However, even ignoring this prior decrease, today’s numbers imply annual growth of just 0.3%. By comparison, the US economy grew at an annualized rate of 3.3% (eleven times faster) in the second quarter. Given slight productivity improvements, the Canadian economy must grow by about 3% annually for employment to keep pace with population growth.

Business Profits and Investment

Canada’s current economic malaise largely results from a lack of investment in productive assets. Even as corporate profits have skyrocketed and governments have slashed corporate taxes, business investment has stagnated.

This trend continued in the second quarter of 2008. Compared to the first quarter, pre-tax corporate profits rose 8.3%, after-tax corporate profits rose 9.0%, and fixed capital investment by corporations dropped 1.0%.

Corporate profits from Canada now substantially exceed investment by corporations in Canada. Historically, non-financial businesses sold shares and took out loans to finance investment far in excess of current profits. Today, these enterprises are using surplus profits to repurchase stock and lend to households.

High corporate profits and falling investment confirm that across-the-board corporate tax cuts entail a huge fiscal cost and have not succeeded in spurring investment. Replacing these costly cuts with a targeted investment tax credit would bolster Ottawa’s deteriorating budget balance and provide a stronger incentive for business investment.

(All figures cited are seasonally adjusted at annual rates.)

PS – With annualized growth of 0.3% in the second quarter, it looks like Jim’s prediction of 0.2% is closer to the mark than my prediction of 0.5%.  However, at least I edged out the bank economists.

UPDATE (Sept. 28): Cited in yesterday’s St. John’s Telegram

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