Finance Committee on Aug. 19th, 2011

[Mark Carney]

Thank you for the question. It's a very important question, and it goes to the heart of where growth is going to come from for this country over the medium to long term.

One of the main sources of growth is, in our opinion, going to have to come from this trade diversification. Now, let me say at the outset that the United States, for all its difficulties, is still the largest economy in the world. We expect there will be ups and downs, but the U.S. economy is still going to grow at a reasonable pace. It is not going to grow for some time at the formerly torrid pace that it used to, but it's still a good market for Canadian businesses. We have a privileged position in that economy, and obviously we should do everything we can to retain that position.

That said, the opportunities in emerging markets for this country are immense. The simplest and most straightforward opportunity comes through our commodities sector. Whether we trade directly with these economies or not, we feel the benefit of their demand for commodities that we export, from base metals and precious metals through to the energy complex. Emerging economies, and China in particular, are the main drivers of these commodity prices. We get the net income benefit of that.

While there is always going to be volatility around commodity prices, we expect that all things being equal, commodity prices are going to remain relatively elevated for the foreseeable future. In our opinion, that provides a degree of confidence in terms of further longer-term investments in that sector, which could include pipelines, geographic diversification, and other aspects that are being looked at very intensively.

The other aspects, though, are where we have a lot of room. Let's say the glass is half full. We have a lot of room to expand both in the manufacturing sector and in the export of services. We have lost market share in the major emerging markets in those areas in the last decade, so one of our messages is that these economies are accounting for more than half of global growth. It's three-quarters, as you referenced. It's actually probably 80% right now, unfortunately, with the drop in Europe and the U.S. They're accounting for more than half of the growth in manufacturing exports as well, and capital good exports, so there are real businesses that Canadians all the way through the supply chain can take advantage of.

It's not easy, in that it will take a sustained effort to develop these markets and to get into those new supply chains, but the secular trends here are fundamental. I'll give a couple of very quick examples and then stop, Chair.

Let's look at China and India. Every 18 months of urbanization in China and India equals the entire urban population of Canada. They house that many people every year and a half as they move to the cities. As well, globally there are 70 million people moving every year into the middle class from the major emerging markets. There is tremendous opportunity here. Government can obviously help with trade deals such as the deal with Colombia, which I know members of this committee supported, and with other important diversifications.

I have one last thing, which is that the flip side is also important. We need to recognize that these major emerging markets--particularly China, or the Asia complex, if you will--are major providers of long-term capital. We could take advantage of that for inward investment into Canada and use it to export higher quality products to these countries.

[Tiff Macklem, Senior Deputy Governor, Bank of Canada]

Could I just add one brief point?

[The Chair, Conservative, James Rajotte]

Please be very brief.

[Tiff Macklem]

I will just add that for some time we have been stressing the need for Canada to increase its exposure to emerging markets. I'm on my way to India this evening and will be meeting with senior officials at the central bank and in the government, as well as with a number of leaders of industry. We make a lot of trips to Europe; it is important that we also go and visit emerging markets.

[The Chair, Conservative, James Rajotte]

Thank you.

We'll go to Mr. Brison, please.

[Scott Brison, Liberal, Kings—Hants, NS]

Welcome, Mr. Carney and Mr. Macklem, and thanks for being with us today.

In your latest bank report, you cited Europe as the biggest downside risk for Canada, and since then we now see the very real possibility of contagion spreading through the European banking system. Do you believe that recent events have increased significantly the possibility of a full recession in Europe and the U.S.?

[Mark Carney]

Thanks for the question.

It's an important issue. The recent events in Europe, in our opinion, will reduce growth in Europe for the second half of this year and into 2012, and probably into 2013 as well, so it will have a long tail.

One of the advantages that Europe has is that its core, Germany in particular, is incredibly leveraged and exposed to the major emerging markets through manufactured commodities, precision instruments, and other very high-value-added products, so the multiplier effect that Germany and, through Germany, Europe gets is helping to support growth in that economy as a whole. The core of Europe has some very strong fundamentals; there are some difficult issues in the periphery.

With regard to the situation with European banks, there are challenges for the system as a whole in terms of the level of capitalization of those institutions. They need to continue to build capital over time in an appropriately paced fashion. They need to build capital in order to provide credit.

Since the events of 2008, some very important mechanisms have been put in place among the major central banks. I'm speaking specifically about U.S. dollar swap lines and other cooperative arrangements that have been put in place between central banks. These measures will help ensure that liquidity shocks will be mitigated. They can't be eliminated, but they can be mitigated, which should reduce some of the contagion from those events.

[Scott Brison, Liberal, Kings—Hants, NS]

You said in your statement that austerity measures in Europe would dampen growth in Europe. Would your assumption be that austerity measures or government cuts in Canada would have a similar effect?

Second, you also advocated heavy investments to strengthen productivity. Would you suggest that in the event of an economic downturn in Europe and the U.S., we should increase emphasis on those kinds of investments to strengthen productivity?

Finally, what kinds of investments are you specifically advocating to strengthen productivity?

[Mark Carney]

Central to our forecast in the July MPR, and an element of the forecast that still very much holds, is the idea that we expected a rotation in demand from the public sector to the private sector and from the housing sector to business investment during the period from the recession through to the initial recovery. Then one of the biggest question marks has been how the export sector would fare in a challenging global environment.

Consistent with the announced fiscal plans of the federal and provincial governments, we expected the contribution of government, which was very significant and helpful during the depths of the recession, to fall. That is what's happening, and it's entirely appropriate.

On the issue on investment, there is no question in our opinion that the private sector will need to sustain investment. In aggregate, we're still lagging behind where investment would be in a recovery. We expect it to continue to grow strongly. We do need to grow productivity, and that's central for the private sector.

Government can help with strategic investment. Those are decisions for governments, but government can also help by creating an environment that facilitates such private investment, including using foreign capital as effectively as possible for longer-term private investment that will not just have impacts on productivity but also help build export capacity in this country.

[Scott Brison, Liberal, Kings—Hants, NS]

I would appreciate it if you could again go back to the situation in the U.S. and in Europe.

Do you believe that the chances of a full-fledged recession in Europe and the U.S. are greater now than you predicted in your last report? The situation has changed. Has the possibility of a full-fledged recession increased since your last report?

[Mark Carney]

Our base case view contained in the report was for modest growth in the United States and Europe. Given recent events, including data revisions to U.S. numbers and tightening of financial conditions because of recent events in financial markets, our expectation for both of those jurisdictions is that growth is going to be lower. That is what—

[Scott Brison, Liberal, Kings—Hants, NS]

Is there a possibility of a contraction?

[Mark Carney]

No, that is not our expectation. Our expectation is that growth is going to be lower. I would not say that our base case view has been revised such that there will not be growth in those economies. That is not the case.

With regard to the very short term, I should stress that there was a big supply chain impact in both the United States and Canada because of the events in Japan on March 11 and afterwards. It was a hard hit for both of our economies, as well as on other economies, in the second quarter, but they're largely coming off that: the auto plants that were shut down have been restarted, and we're going to see a lift from that in both of our economies, at a minimum, among other factors.

[The Chair, Conservative, James Rajotte]

Thank you, Mr. Brison.

We'll go to Mr. Adler, please.

[Mark Adler, Conservative, York Centre, ON]

Thank you, Governor, for being here this morning.

I want to preface my question with two personal anecdotes. Before being elected to Parliament, I was head of the Economic Club of Canada. Last year we were looking at expanding on the international scene and went to Hong Kong. What struck me when I was there was the real interest in Canada among both private sector and public sector policy-makers. What was Canada's secret? Why was Canada doing so well in the financial sector? That was a real source of interest in Hong Kong. It was really striking.

As well, when I was going door to door during the campaign, the dominant issue among people was the economy. They were very impressed that our economy in Canada was doing so well vis-à-vis those of other countries around the world.

We have just heard from the Minister of Finance, who is in close consultation with his G-8 counterparts around the world. In fact, he just penned an article that appeared in a number of papers globally this week. As part of the response to the global economic turmoil, we have recognized the need for global international cooperation. These initiatives have been proceeding at a good pace in recent years, through Basel III and the Financial Stability Board. I know you're very familiar with these fora and initiatives.

Could you give us an update on these initiatives and why it's important not to lose sight of the objective of maintaining global financial stability?

[Mark Carney]

Thank you very much.

I would echo very much your first point in terms of the interest in the lessons from Canada's strength or performance in the financial sector. As Mr. Macklem references, he's in India--we're often in Asia--so that we can learn from each other, but candidly, we're also there so that we can add to the profile of the Canadian financial sector and encourage longer-term relationships to the benefit of our citizens.

In terms of the agenda, there is a very heavy reform agenda, and it can be sometimes mind-numbingly dull or complicated in all the acronyms. That is by design, by the way, so that nobody knows what we're doing.

[Voices]

Oh, oh!

[Mark Carney]

Let me try to strip it down. You referenced Basel III, and that's absolutely right. Basel III is the standard for how much capital and the type of capital that banks have to hold, and how much liquidity they should hold as well. The core of Basel III makes the world's banks look more Canadian.

There are some innovations to the way we did things in Canada as well, but basically we added on top of all the complexity a very simple test that will apply globally, which is how many assets you have over how much base capital. You shouldn't let that get too big, because there are limits to knowledge, and the things you think aren't risky tend to be the things that really do have a lot of risk. That was one of the core lessons of the financial crisis and one of the reasons we did well.

We've added some very common sense elements to the standard. We've stripped out a lot of financial engineering in the quality of capital so that equity is true equity and there is realy some loss absorption base there. The important thing is going to be to make sure that people implement it, and that they implement neither too quickly nor too slowly, but in a timely manner. The world's banks were shown to be woefully undercapitalized as a whole--not the Canadian banks, but the global banks--and that was part of the reasons for the crisis.

We don't have time to go into it now, but one of the things we're really focused on at the bank and through the financial stability board is making sure that all these great rules that have now been written are actually implemented, not just in Canada--where they will be, without question--but also in Europe, the United States, and our major partners.

I will quickly mention the second two things. There are a series of very complex initiatives that work on the plumbing of the financial sector. They work through the short-term repo markets, which are one of the core markets through which banks are funded, and the derivative markets. The point of those initiatives is to remove the types of risks that are still present in global markets in relation to how the failure of a certain bank would affect all the other players. There is still tremendous uncertainty about that. If you can neutralize that risk, then a certain bank can fail if it makes mistakes--and it should fail--but others can get on with their business. Then we won't have to have special sessions during August, although we're always happy to do them.

In terms of the repo market in Canada, we have made some serious changes that should be on stream later this year or early next year. Those changes will further improve our functioning in that area.

The last thing is the other big element of initiative. We have focused on the banking sector as a whole, “we” meaning the global community. Give or take, that is anywhere from a third to a half to a maximum of two-thirds of the financial sector in any given country. In Canada it is about one-half. What about the whole other side? Some people call it “shadow banking”; we prefer the term “market-based finance”, because it's actually about having markets and having the markets working. We need to look at the interaction between markets and banks and ensure that they are resilient, so that we don't get effects from markets cascading back onto the banks and ending up affecting the ability of individuals, Canadians, to have a mortgage or to borrow for somebody's education or for a new business investment.

[The Chair, Conservative, James Rajotte]

Thank you, Mr. Adler.

Mr. Mai, you have five minutes.

[Hoang Mai, NDP, Brossard—La Prairie, QC]

Thank you, Mr. Chair.

I would like to thank the Governor of the Bank of Canada and Mr. Macklem for joining us today.

Despite the Canadian economy's relative strength compared to its main trading partners, our economic performance is still below its true capacity.

Could you comment on the difference between our current situation and our potential?

[Mark Carney]

First of all, I would like to welcome you to this committee.

You are right, the Canadian economy is not currently operating at its full capacity, which is normal after a recession. The gap between demand and our economy's full potential is still not nearly as wide as in the United States.

Every October, the bank releases a projection, or an estimate, for the potential growth rate of the Canadian economy. It is around 2% per year. It is the result of productivity and a growing workforce in Canada.

The gap between the potential demand and the level of the Canadian economy is currently at almost 1%. That is the bank's estimate.

[Hoang Mai, NDP, Brossard—La Prairie, QC]

We have heard that Canadian companies have about $500 billion at their disposal, but they are not reinvesting it in the Canadian economy. In your view, how does this affect Canada's ability to compete?

[Mark Carney]

That puts our economy at an advantage. The balance sheets of our companies are very strong; those companies have a lot of liquidity. As we were saying, there are many business opportunities on emerging markets. There are a lot of opportunities for us to increase our productivity.

It is crucial that Canadian companies stay the course. They started to invest in the middle of last year. At the moment, investments are very high in Canada. All indicators, meaning conversations, bank surveys, and so on, suggest that our companies are going to continue to make considerable investments in the future.

It is a necessity. They can use their liquidity. They can also borrow if they need to.

[The Chair, Conservative, James Rajotte]

We'll go to Ms. Glover, please.

[Shelly Glover, Conservative, Saint Boniface, MB]

Thank you for being here.

Thank you so much for your presentation. It really was enlightening to some of us.

I'm going to try to sum up some of the things that I've heard.

Page 2 of your presentation states that “In tandem, federal and provincial fiscal stimulus provided important further support to domestic demand, contributing significantly to Canadian economic growth through 2009 and 2010.”

I was glad to see that, because the NDP voted against the stimulus during that period.

Then, later, you said that it's now entirely appropriate to stop spending, yet here today the NDP is saying, “Spend”.

On the other things that you've commented on, I'm trying to figure out why the NDP and the government are on two sides of this economic page. When you talked about jobs in your presentation, again on page 2, you stated that Canada, thanks to things like Canada's economic action plan, “...has recovered all of the output and about 140% of the jobs lost during the recession”, yet the NDP continues to say that we should focus on creating jobs, something the economic action plan--which they voted against--was doing and is continuing to do as we move forward.

Then you said something very important. You said that trade diversification is at the heart of where growth will come from. We've seen our Prime Minister pursuing that and we've heard Minister Flaherty talking about trade in China. We have negotiated approximately 10 agreements. Given that we have just signed some last week, during the Brazil trip that the Prime Minister took, we have signed more than 10. We are negotiating 50 trade agreements. The Liberals only signed three over 13 years; we're only into our sixth year as government, so I think we're doing pretty well.

At the heart of that, you stated that a government can create an environment to allow the private sector to invest in growth and you pointed out how important it is to do that. Would you agree, sir, that things that we've done as a government, including implementing a hiring credit for businesses, lowering corporate tax rates, extending the accelerated capital cost allowance, and negotiating free trade agreements show that we're on the right track?