Carney on Business Investment: You Read It Here First
Nine days ago, I posted aboutÂ private non-financial corporations accumulating cash rather than investing in Canada. A week later, the Bank of Canadaâ€™s Monetary Policy Report (MPR) noted â€œthe relatively high level of liquidity held by the non-financial corporate sector and weak investmentâ€ (page 19).
By my count, the document expresses concern eight separate times about anemic business investment. It acknowledges the point I have been making about capacity utilization, suggesting that business investment â€œis likely to remain sluggish relative to previous recoveries, owing to high levels of unused industrial capacityâ€ (page 11).
But then the MPR changes tune: â€œNevertheless, business investment is expected to increase to levels consistent with previous recoveries, driven by the need to expand capacity and to increase productivity in a more competitive international environmentâ€ (page 23). Mark Carney repeated this language in his remarks.
The two statements seem almost contradictory. Donâ€™t the â€œhigh levels of unused industrial capacityâ€ obviate â€œthe need to expand capacityâ€?
TheÂ line about productivity and competitiveness is also questionable. Neoclassical economics suggests that business managers always try to maximize profits, with or without international competition. They will make a productivity-enhancing investment if the resultant cost savings are expected to exceed the investmentâ€™s cost.
Does the Bank of Canada subscribe to an alternative theory of corporate behaviour? Does it believe that business managers are lazy and try to achieve cost savings only when prompted by international competition? Does it think that productivity is an end unto itself for corporate Canada?
International competition is a double-edged sword. Companies could build capacity here to supply not only Canadian markets, but also foreign markets. Or they could build the capacity abroad to supply both Canadian and foreign markets.
There is no prima facie reason to expect â€œa more competitive international environmentâ€ to increase investment in Canada. In recent years, such competition instead seems to have shifted investment overseas.
The central bankâ€™s mystifying words may simply provide cover for its actions. Two days before the MPR, the Bank of Canada raised interest rates again. This policy encourages cash accumulation and discourages investment in three ways.
First, higher interest rates mean higher returns on cash balances and higher costs on loans to finance investment. Second, higher interest rates diminish the possibility of inflation eroding the value of cash balances and hence the incentive to invest in physical assets as a hedge against inflation. Third, higher interest rates push up the exchange rate, which increases the relative value of Canadian cash holdings but reduces the competitiveness of Canadian production and exports.
The Bank of Canada is serving up anti-investment policy with a side of pro-investment rhetoric.