The outlook for capital spending in uncertain economic times

In his recent co-authored book,[1] former federal Finance Minister Bill Morneau shines a bright light on Canada’s economic growth challenge. Despite a rapidly expanding population, Canada has struggled to generate meaningful gains in “real output” on a per capita basis. And according to the OECD, Canada will be at the very bottom among 38 advanced economies in projected (per capita) economic growth over the next few decades.

At the heart of Canada’s growth malaise lies lacklustre productivity – how quickly the economy expands for each hour of additional work. Canadian labour productivity currently stands at less than 75% of the U.S. level and has continued to trace a gentle declining path in the last decade or so. Output per hour in the fourth quarter of 2022 was essentially unchanged from three years earlier. This points to stagnation – or, more likely, a decline –in Canadian living standards.

Non-existent productivity growth mainly reflects sluggish investment in many of the things that make businesses and their employees more productive over time: machinery and equipment; factories, research labs, and other production facilities; intellectual property; digital tools, platforms and other advanced process technologies; and engineering infrastructure. Compared to the United States, Canadian businesses invest only 55-60% as much in such productive assets, on a per worker basis.[2]

Even though interest rates in Canada were exceptionally low from 2009 through 2021, capital investment remained fairly muted over most of the period. There was some recovery in investment coming out of the worst of the COVID-19 pandemic in 2020, which saw a steep fall in capital outlays. However, in Q4 of 2022 real non-residential investment decreased sharply, with investment in machinery and equipment down by almost 30% on a quarter/quarter basis.

By the end of last year, overall Canadian capital spending was roughly were it stood before the pandemic.[3] Put simply, that level of investment is not going to fix the problem of near-moribund Canadian labour productivity. Moreover, much of the increase in investment that occurred in 2021-22 following the COVID-induced slump in 2020 was driven by surging public sector capital budgets.

There are nonetheless a few glimmers of light. In its 2023 investment intentions survey, Statistics Canada reported that Canadian organizations (including those in the public sector) expected to boost capital spending by $13 billion this year, a 4.3% increase from 2022. In the private sector, most of the growth in 2023 is in commodity-producing industries, particularly energy and mining (together accounting for half of the overall gain). Investment plans are softer across most service-producing industries and in the high technology sector. It should be noted that economy-wide inflation has been running significantly above the Bank of Canada’s 2% target for the all-items Consumer Price Index. This means that in “real” terms, the investment growth recorded in 2022 and anticipated for this year is far more modest.

As it happens, British Columbia is below the Canadian average in planned 2023 capital investment, with total outlays predicted to drop by 3.3% from last year. This is partly due to less investment spending in the LNG and pipeline industries as certain large projects move closer to completion.

The pattern of generally feeble private sector investment is a dagger aimed at the heart of Canada’s future prosperity. The 2023 federal budget unveiled several new tax incentives designed to accelerate investment in renewable energy, clean technologies, and the shift to lower-carbon production processes across the Canadian industrial economy. While these initiatives will produce some economic benefits, they are unlikely to kick-start a broader investment renaissance. Canadian policy-makers have yet to acknowledge the severity and persistence of the country’s investment problem.

[1] Bill Morneau and John Lawrence, Where to from Here: A Path to Canadian Prosperity, 2023.

[2] William Robson and Mawakina Bafale, “Decapitalization: Weak Business Investment Threatens Canadian Prosperity,” C.D. Howe Institute Commentary, August 2022.

[3] “Canadian Investment Data Paint a Troubling Picture,” Desjardins Economic Studies, March 2023.