Finance Committee on May 1st, 2007

[The Chair, Conservative, Brian Pallister]

We'll just leave it at that mysterious level and move on to Madam Wasylycia-Leis. You have seven minutes.

[Judy Wasylycia-Leis, NDP, Winnipeg North, MB]

Thank you, Mr. Chairperson.

Thank you, Governor.

First, like my colleagues, I would like to thank you for your years of public service, at least as far as I know, in the Department of Finance, the Department of Health, and then as Governor of the Bank of Canada. You've given a great deal of your life to this country, and we thank you for that and wish you well in your retirement.

Having said all those nice things, I want to question you where I actually first started questioning you when I became the finance critic and you were at committee. And that has to do with the failure of you and your office to really address the crisis in manufacturing.

You continually talk about Canada operating above capacity, or at full capacity, without acknowledging or addressing the fact that the bottom half of Canadians haven't seen any change in their wages. We also have this serious crisis in jobs in the manufacturing sector, with, obviously, the rise in the Canadian dollar--again today--hurting rather than helping that situation.

I think the fact that we've lost one in ten manufacturing jobs in the last seven or eight years, that we've lost good-paying jobs, and that we have many people struggling to make ends meet and not seeing much hope for the future is something we have to constantly focus on. I think that is something you could address as Governor of the Bank of Canada.

I'd like to hear from you if there are some parts of monetary policy that could actually address these concerns.

[David Dodge]

There are really two issues you've raised, and they're both important but different. The first is the evolution of income distribution in this country.

For the last 20 years we have seen the distribution of earned income actually grow more unequal. Now, we are certainly not a world leader in this increasing inequality, but earned income is clearly more unequal as we sit here in 2007 than it was in 1987, or in particular than it was in 1977, at the end of the last long productivity boom.

This is a global phenomenon. Part of it is obviously due to technological change, part of it is due to the fact that markets have gone from being local to national to being global, and that tends to pull the income distribution apart.

In this recent issue of the IMF World Economic Outlook there's an interesting chapter on that, but it is quite clear--and this isn't a manufacturing/non-manufacturing issue--it doesn't matter what sector you look at, you see this pulling apart of earned incomes. This is a real issue going forward.

Historically we've gone through periods like this, and it tends to reverse itself over time, but it is certainly one that is worthy of study and reflection on the part of this committee and on the part of Parliament.

I think that actually is an issue that is quite different from the relative shares of employment we have in manufacturing services and primary industries. We had really quite a sharp increase in the share in manufacturing employment in the 1990s, when we had really rather depressed resource prices and when we had to crowd in some employment because governments were subtracting from the economy over that period. So it's actually not surprising that when those conditions reverse, we would see some decline in the share of manufacturing.

I guess what I would say is it's not the fact that there's an absolute decline in manufacturing employment; that is, in a sense, part of the normal working of the economy. What is really critical is, is that being driven because we are becoming globally less productive than others, or is that driven, as I said, simply by the evolution of prices? That is a serious question, and it is a serious issue for Parliament and for the government as to what policies ought to be in place to support reasonable levels of investment in the manufacturing sector so that we can actually increase the productivity.

[Judy Wasylycia-Leis, NDP, Winnipeg North, MB]

I appreciate all of that. I guess I still wonder if there wasn't something that could have been done over the last few years from your office in terms of using monetary policy to lessen the impact or to help address the looming crisis and the present crisis in the manufacturing sector. There are those who think that was possible.

I just want to quote from Andrew Jackson, who has said he appreciates all of the consultations between your office and labour and people who have been raising these issues, but he does say that he thinks monetary policy as a whole should and could have somewhat lessened the scale and severity of the current manufacturing jobs crisis.

I guess I'd like to know if there are regrets you have around not addressing this issue, or if there's anything you would say to your successor on this front. Or is it only something you think Parliament can address and it's not related to monetary policy, and if there isn't in fact--

[The Chair, Conservative, Brian Pallister]

Your time is well past.

Regrets, you have a few. You can mention them later, Mr. Dodge, in response to another question, perhaps from Mr. McKay, who has five minutes for his questions.

[John McKay, Liberal, Scarborough—Guildwood, ON]

Thank you, Chair.

I too want to add my thanks for your public service, Governor, but I also want to thank you for your personal decency over the number of years that I've been here, on both sides of the table. Your willingness to engage particularly those of us who are not formally trained in economics and try to explain to us some of the intricacies is much appreciated. I personally want to thank you for your efforts to help educate us all.

I want to go back to Mr. McCallum's question with respect to interest deductibility. What we have at the present time is a statement in the budget that says interest deductibility won't be allowed. We read in the press that the minister seems to be backing down on this rather blunt statement in the budget, and now, instead of having an immediate application, maybe he'll extend it over 10 years, or phase it in over 10 years. But it's kind of hard to see how the statement as recorded in the budget can actually be modified.

He has certainly caught an earful from the business press and he has certainly caught an earful from those of us who actually think about these issues. As you've rightly pointed out, this is an extremely delicate area. One can't just simply blunder into it and hope that, somehow or another, all the rest of the countries in the world will go along with us.

So I am encouraged by your remarks. What I'd like to hear is whether you think the minister's statement, the statement that he seems to want to prolong this process, is actually a viable solution or whether he should actually be going back to the drawing table and dealing with those abuses that would offend all of us.

[David Dodge]

Look, no minister of finance wants to throw the baby out with the bathwater, and I'm sure this minister of finance doesn't want to do that either.

This is a technically difficult area. At the same time, it is annoying, it is revenue loss, and it brings the belief of Canadians that we have a fair tax system into question when there are some practices that actually go on. The great difficulty is to try to contain those practices that are clearly abusive and not within the spirit of the act, while ensuring that the act does encourage Canadian companies to grow globally. That's the very difficult technical job of actually writing the law to accomplish the goal that I think the minister stated, to stop what appear to be abusive transactions.

All I can say is, from my own experience, that is something that we definitely ought to go at, but it's not going to be so easy from a legal, law-writing, regulation-writing perspective, and the minister is perfectly aware of that.

[John McKay, Liberal, Scarborough—Guildwood, ON]

I don't disagree that this is an extraordinarily complex area—issues of extraterritoriality, the application of the income tax provisions to other jurisdictions. There are ways in which companies conduct their other business. But it seems to me that the minister has chosen to use the bluntest instrument possible in putting the statement in the budget and then leaving everybody to wonder how in heaven's name this is going to affect them, particularly with respect to, say, businesses contemplating the acquisition of foreign assets. It does strike me as something less than a nuanced application of what we all agree is an extraordinarily complex area.

[David Dodge]

I won't comment on nuances. It is complex. I guess all I would say, from my conversations with the minister, is that he fully recognizes the complexity of dealing with it, but also the importance of having an Income Tax Act that appears to be reasonable and fair, because after all, we rely largely on voluntary compliance. So I think it certainly is an issue that is very much worthy of being dealt with. But it's not easy, and certainly I did not take the statement that everything would be done in a blunt manner. The intent is to move forward to find a way to do this efficaciously, I think.

[John McKay, Liberal, Scarborough—Guildwood, ON]

Thank you.

[The Chair, Conservative, Brian Pallister]

Thank you, Mr. McKay.

Certainly we recognize, Governor Dodge, that the issue of deductibility is complex. We know it has been an ongoing issue for some time. Members of this committee are aware of numerous reports of auditors general who have highlighted this as a serious and growing concern. And despite that advice and the advice of others, such as Jack Mintz, in his business taxation report, no action has been taken to date.

Mr. McKay's comments pertaining to the degree to which the minister is communicating his concern about the issue are quite valid. But I wouldn't want anything that Mr. McKay or others have said to indicate that it was the position of this committee that action should therefore not be taken because this is a communications challenge. I don't think that should be the message going out.

We'll have Mr. St-Cyr for five minutes.

[Thierry St-Cyr, Bloc, Jeanne-Le Ber, QC]

Thank you, Mr. Chairman.

I'd like to come back to the fight against inflation. Canada's economy is not homogenous. It is diversified and economic conditions in Quebec's industrial sector are different from conditions in Alberta or the West. In many cases, we are currently experiencing an overheating of the economy, major expansion, a high inflation rate, rising rental and commodities costs, etc. Everything is going through the roof, except in Quebec, where conditions are quite the opposite. Many sectors, including the manufacturing sector, are facing major problems in terms of growth.

Bearing this in mind, by definition, any anti-inflation policy will necessarily benefit, and be more useful, to Alberta and other provinces in the West which are facing problems with inflation, than it will be to provinces like Quebec or even Ontario, where these problems don't really exist.

In developing your anti-inflation monetary policy, how do you reconcile these two realities, these two different economic structures, so that everybody fairs well?

[David Dodge]

You're entirely right, it's always hard when there are major fluctuations in the relative prices of commodities. The manufacturing sector is indeed far more concentrated in the Montreal region, in southern Ontario and in Winnipeg. That means that when the price of manufactured goods drops, in relative terms, the situation is much worse in these regions which have to bear the burden of the adjustment. The situation was completely the opposite in the mid 90s when the price of commodities slipped. It was harder at that time for Alberta and the other regions in Canada which rely on the mining industry. There are always these kinds of adjustments, and in Canada, given that the various sectors are concentrated in certain regions, it's even more difficult because you can't simply quit a job that is 10 kilometres from your home and find another one that is five kilometres away.

This has always been the case. And in that sense, this answers Ms. Wasylycia-Leis' question. These kinds of adjustments are important. And it is important to have policies which facilitate, rather than hamper, these adjustments.

[Thierry St-Cyr, Bloc, Jeanne-Le Ber, QC]

So if I've understood you correctly, you can try and maintain the inflation rate at between 1% and 3%, at Canada's traditional level, but it's possible that in certain regions our policy won't be aggressive enough because of higher inflation, whereas in another region, the policy will be overly aggressive. There's no real way of regionalizing our policy. This is why it is a national policy.

[David Dodge]

We cannot do things differently. It would not be a good idea to have a regional policy because it's important that less profitable industries' and companies' resources be transferred to more profitable industries. That's how we maximize our financial well-being. Such transfers are nevertheless difficult, especially in Canada, because the industries are concentrated in certain regions.

Before I hand the floor over to Paul, I'd like to point out that the services sector is extremely important. The value-added component of the financial and engineering sector is very high. These industries are concentrated in the Montreal region and south of the St. Lawrence. Some of them required specialized workers and some jobs were transferred from manufacturing industries to services industries. Such transfers are important.

[The Chair, Conservative, Brian Pallister]

We'll continue with Mr. Wallace.

[Mike Wallace, Conservative, Burlington, ON]

Governor, thank you for coming today, and of course thank you for your service to Canada.

I just have a few questions for you. I did read over your monetary report that you had given me. To be frank with you, I didn't understand everything completely, but that's part of the learning process that I'm here for.

One area that I found of interest was household credit. You say in your report that you don't really have a great model to capture household credit, but you're using other people's information. When I look at the chart, household credit is going up significantly, but you say that despite higher indebtedness, households remain financially sound. Can you tell me, from an individual Canadian's point of view, what the effect of larger debt is in terms of your overall view of how the economy is working?

[Paul Jenkins]

Perhaps I can respond to that. We do track these credit numbers very, very carefully, both household credit and business credit, in terms of other indicators that we look at, in terms of the overall performance of the Canadian economy. In the case of the household sector, in looking at the growth of household credit, we take a balance sheet perspective, so we look at the rate of growth of household sector credit, but we also, obviously, look at what that credit is being used to purchase, what's on the asset side of the household sector balance sheet. You then need to drill down to the net worth of the household sector. You want to be satisfied that if they're taking on additional credit, the assets they're acquiring, whether they be financial or real, retain their value so that the overall net worth of the household sector continues to grow.

The other factor that we look at very carefully is the debt service ratio for the household sector. The fact is that the debt service ratio, notwithstanding the increase in overall household credit, has remained very, very low, and of course that is a function of the fact that we have very low interest rates in Canada. That's one of the byproducts of a low, stable inflation environment.

[Mike Wallace, Conservative, Burlington, ON]

I appreciate that.

We talk about exports of raw materials being under some pressure because of the U.S. economy but that manufacturing exports are up, and a few other areas. Is that in relation to each other, or is that separate from each other? Is manufacturing up compared to the decline, or is it real, actual numbers--manufacturing exports are up? I wasn't sure whether there was a combination there or not.

[Paul Jenkins]

No. In terms of overall growth rates, we see exports rising, but not at as rapid a rate as imports are growing.

Going back to one of the earlier discussions about the strength of domestic demand in the Canadian economy being one of the main drivers, linked to it has been a fairly strong growth of imports. When you net those out, net exports actually have been a drag on the Canadian economy through 2006. We're looking to see net exports remaining a drag this year and, as the governor noted earlier, basically becoming neutral in 2008 and 2009.

Yes, we are seeing exports growing, but not as rapidly as imports, given the strength of the domestic economy.

[Mike Wallace, Conservative, Burlington, ON]

You also show a chart that has crude oil and natural gas pricing going up, from my perspective on a relatively straight line up.

I have two questions. One, is that due to demand or is it due to supply? And what does this do to our inflation rate?

[David Dodge]

Well, which blade of the scissors cuts?

It truly is that we have global demand. Certainly what markets think is that over the relevant time horizon, global demand is going to grow perhaps at the rate of supply or slightly faster, so you get a futures curve that has a bit of an uptick to it.

We're not experts in the oil industry. There is no model that we have found that does any better than using as an assumption what the market has out there for futures prices. That's not very good either, but it's the best we have, and that's why we use it.

[The Chair, Conservative, Brian Pallister]

Mr. Wallace.

[Mike Wallace, Conservative, Burlington, ON]

We spend a lot of time considering the value of the Canadian dollar vis-à-vis the United States dollar. What we don't spend a lot of time on is the value of the Canadian dollar versus that of other currencies outside of this continent.

Would you like to speak a little bit about the opportunities and the challenges that may be presented to Canada as a consequence of the downward direction of the U.S. dollar versus other currencies outside of North America?

[David Dodge]

That's an extraordinarily good question. We spend a lot of time working on this issue.

First of all, think of the world as one gigantic closed economy. We don't trade with Mars yet, but we trade a lot with each other. What we are experiencing is a rather prolonged period now in which the United States has been the principal absorber of savings. Their savings have not matched their domestic investment, so they've been sucking in imports. Asia and, with the rise in oil prices, the Middle East have been the big suppliers of savings to the world. So you need an adjustment to go on.

Part of that ought to be some appreciation of exchange rates for the Asian countries and the Middle East. Part of the adjustment ought to be that their domestic demand has to grow a bit faster. And part of it is that the U.S. domestic demand is going to have to grow a little bit more slowly over a period of time. That's the basic adjustment that we know has to go on, and it's the basic adjustment we've been pointing to in G-7 communiqués for quite a while now.

The question is, what policies will facilitate this in the smoothest manner to allow the world to continue to grow at something close to 5%? Therein is the great challenge. It's a challenge for everybody, but it's a challenge for us because of the structure of our economy.

What we've been working on is essentially a three-pronged strategy: first, to get more flexibility in exchange rates around the world so that all the burden doesn't fall on countries such as Canada, Australia, and the U.K., which have flexible exchange rates; second, to try to persuade the Asian economies to take the social measures and other measures to reduce the amount of their precautionary savings so that they increase their demand; and finally, of course—the other side of the coin—the United States has to do a little bit to rebalance the weight that goes on consumption.

This is a very tricky thing, and provided everybody is moving roughly in the right direction and roughly quickly enough, the chances of a relatively smooth adjustment to that situation are high. To the extent they're not—or even worse, Mr. Chairman, that they're perceived not to be—playing by these general rules of the game, there's a huge danger of protectionist sentiment building up. For us in Canada, that would be an absolute disaster, because we'd be caught in the tailwind of U.S. protectionism that, at least ostensibly, was aimed at Asia but sweeps us up in the process. That, then, can lead to a downward spiral in global growth.

That's what we as a country, whether in the ministry of finance or whether as ourselves at the Bank of Canada, have been working extraordinarily hard to try to promote. But it's not easy.