Rotman Executive Summary

Why isn't Canada in a recession and what does it mean for our long-term prosperity?

Episode Summary

Professor Walid Hejazi joins the Executive Summary to explain the macro-economic trends keeping the economy chugging along and kept us out of a recession (so far), and why they might be detrimental to our economic health.

Episode Notes

Professor Walid Hejazi joins the Executive Summary to explain the macro-economic trends keeping the economy chugging along and kept us out of a recession (so far), and why they might be detrimental to our economic health.

Show notes: 

[0:00] In 2022 and 2023, talk of recession was everywhere.

[0:20] Historically, when central banks raise rates to fight high inflation, recession follows – though this hasn’t been really tested since the 1980s, according to professor Walid Hejazi.

[1:17] And as of October 2023, despite numerous predictions of a recession, none have come to pass. So does that mean we’re economically in the clear? And why is that potentially a bad thing for Canadian prosperity?

[2:45] Important caveat: We interviewed Walid in August, recorded the rest of the episode in mid-September, and it airs in October, and while the economy moves slowly, it can sometimes move quickly and in unexpected ways.

[3:27] What is the technical and practical definition of a recession?

[3:47 Does Canada meet either of those definitions? No – we saw growth in GDP and jobs in the first quarter, a small contraction in the second quarter, and net gain in jobs in that same time period. 

[4:20] Why did everyone think we were headed towards a recession? Because history tells us that’s the way it is.

[4:47] And the leading indicators have all been pointing that a recession is imminent.

[5:30] But there’s growing optimism that the central banks will have achieved a soft landing.

[6:15] Economist are surprised. They predicted the rate hike cycle would slow the economy. It did, but not as drastically as expected.

[6:38] Walid believes there are four reasons we haven’t tipped into a recession yet: low interest rates for too long, the unexpected war in Ukraine, the government’s COVID stimulus and Canada’s immigration policy.

[8:41] Are those sources of resilience a good thing? Maybe. But that resiliency might be detrimental to the long-term prosperity of Canadians.

[9:13] Why do we have a hot labour economy?

[10:03] How might our current approach to immigration cause a problem?

[10:50] The heavy debt load as a result of COVID-19 means focus on growth spending takes a back seat to interest payments.

[11:35] this is an opportunity for governments to think about the long term, but Walid doubts they’ll be able to think beyond the short-term.

[12:11] 50 years ago, Canadians were third wealthiest by household, globally. Today, we’re 15th, and our PPP is about 30 per cent lower than the U.S.

[12:45] This is a problem as we look to repay our debts. The wrong way to pay back debt if you want a prosperous economy, is to raise taxes; the right way is to make the existing workforce more productive and wealthier.

[13:20] Walid believes Canada needs to fundamentally become more innovative and productive, and diversify into higher-valued industries.

[13:48] To do that, we need to first remove protectionism;

[14:03] Second, we need to decrease the burdens or credentialing on new immigrants;

[14:25] And third, we need to remove the bureaucratic red tape that hinders innovation.

[15:18] What we need, Walid says, is bold leadership.

[15:49] “Bold leadership is thinking about what's best for Canada's future when it comes to prosperity, and implementing the policies despite the opposition or pushback they get from special interest. Without that bold leadership, a lot can change in 50 years. What kind of a country are we going to leave to our children?”


Episode Transcription

Megan Haynes: Throughout much of 2022 and a good chunk of 2023, economists and headlines bandied about the R word: recession. 

It’s not difficult to understand why – inflation was at a four decade high, and the Bank of Canada was in the midst of its most rapid rate hike cycle this century.

Walid Hejazi: One thing that we teach our MBA students is that whenever you have high inflation, the only way to reduce inflation is with a recession. And the last time we had the opportunity to test this hypothesis was in the early 1980s, when we had high inflation. And in response to high inflation, Central Bank's raised interest rates to slow the economy. And sure enough, we went into a recession. 

My name is Walid Hejazi. I'm a professor of economic analysis and policy at the Rotman School of Management. We just finished a book called everybody's business, how to ensure Canadian prosperity through the 21st century. And the book is really around how to ensure that Canadian prosperity doesn't continue to fall.

MH: So, history tells us rates rise, recession follows. But, that might not be how things shake out this time.

In the fall of 2022, both BMO and RBC predicted that Canada would enter a recession by the end of the year or by early 2023 at the latest; the Conference Board of Canada put our odds at tipping into a recession in the coming months at 70 per cent. 

By January 2023, banks had softened or pushed back their predictions, but still believed a recession was imminent, and one estimate pegged our chances of falling into one in the coming year at 60 per cent.  

In August, inflation hovered around three per cent, before jumping up again to four per cent in September. 

Canada annual GDP still eked out growth, while the country had added more than 300 thousand jobs– shedding roles only in the last quarter. 

WH: And there still might be a recession. But certainly the consensus among economists is shifting away from that most likely scenario that we thought a year ago of having a short lived recession to one we're saying we might be able to avert a recession,

MH: So what did economists get wrong? Why have we defied predictions? And does this mean Canada is economically in the clear? 

Welcome to the Executive Summary - I’m Megan Haynes, editor of the Rotman Insights Hub. 

Musical interlude

MH: Let’s start with an important caveat. We interviewed Walid in early August, and are recording the rest of this episode in mid-September, which is in the middle of the third quarter – so we don’t have all the latest data available. 

At the time of this recording, job action and government shut downs were threatening some of the financial stability in the US, and Canada saw a higher-than expected uptick in inflation. 

And while the economy generally moves pretty slowly, the past few years have shown us that sometimes it can move very quickly, and in somewhat unexpected ways.

And, that is actually a big reason we’re not in a recession yet – according to Walid – but we’ll get into that in a minute. 

First, it’s important to understand what a recession even is. 

WH: The technical definition of a recession is two consecutive quarters of negative GDP growth. That's the theory, in practice, what is a recession? A recession is when there's a significant contraction in economic activity, and widespread job losses. 

MH: Canada’s first quarter in 2023 saw a 3.1 per cent growth in GDP, and we added more than 206 thousand jobs to the market, with unemployment hovering at a decades’ low of 5 per cent. After a revision in September, Statistics Canada confirmed there was a 0.2 per cent contraction in our GDP in the second quarter, and despite some job losses in may, we had a net gain throughout the quarter with more than 84,000 jobs created.

So, we haven’t actually met the technical or Walid’s definition of a recession yet. 

So why did everyone believe we were headed this way? 

Part of the issue, as Walid said, has to do with the fact that the Bank of Canada, and central banks globally are on this rapid rate hike cycle.  

WH: If you look at the actual data, of the last 14 times that the central bank in the US raised interest rates aggressively to fight inflation, 11 of them resulted in recessions,

MH: And in late 2021, as inflation was rising rapidly, a leading indicator of a recession occurred: the yield curve inverted, with short-term bonds delivering better payouts than long-term ones. 

Throughout 2022 – alongside the rate hikes - that inverted yield curve got deeper, something that has historically portended a recession. However, 

WH: A leading indicator does not mean a recession is going to come, it just signals that it's likely.

MH: And right now, all leading indicators – the yield curve, decreased housing starts, unemployment applications, and over-stocked retail inventories – are showing that a recession is likely. 

But there’s a growing sense of optimism that the central banks will have achieved what’s called a soft landing – that is a decrease in inflation, without the associated recession. 

MH: That’s not a definitive – rate hikes take a long time to work their way through the economy. This episode airs 19 months after first rate hike, and as Walid says, 

WH: The last interest rate hike was just a few months ago, which means the full impact of that interest rate increase won't happen for another 18 to 24 months. 

MH: That means, we won’t actually know if the Bank of Canada overshot with its efforts for a while. But current signs point to things being ok-ish. 

WH: Economists are very surprised. We predicted that it would slow the economy, and it has, but it hasn't slowed the economy nearly as much as we expected.

MH: And that’s partially because it turns out the Canadian economy has proven surprisingly resilient. 

In Walid’s view, there are four main reasons why we haven’t tipped into a recession yet. 

First, interest rates were kept artificially low for a really long time, though this is currently being corrected with the rate hike cycle.  

Second, the war in Ukraine exacerbated some supply chain issues and created a big shock in the global economy, making the fight against inflation more difficult by keeping the prices on goods that require wheat and oil high.  

Third, through the pandemic, the Canadian government injected 300 billion dollars into the economy through direct-to-consumer stimulus. Some of that went straight back into circulation as folks replaced lost income as a result of the lockdown orders, but some of it went to savings.  

WH: When we came out of the pandemic, people felt free and had this pent up demand, but they also had all of the savings. 

MH: Indeed, RBC estimates that throughout the pandemic, Canadians saved an additional 350 billion dollars, which they began flooding back into the market after lockdowns eased, making fighting high consumer demand really difficult. 

Finally, Canada had a shift to its immigration policy. 

WH: Last year is the first time in Canada's history that the population grew by a million people in one year. So when you add a million people to an economy, that's going to increase demand, you have to feed these people, they have to buy clothing, they have to live somewhere.

MH: So the economy chugged along, saw a bit of growth, and despite huge numbers of new immigrants, continued to see a hot job market. 

WH: The economy has been so resilient for the reasons that we talked about that incredible government stimulus, the incredible increase in immigration, these it the fact that interest rates were a lot lower than we thought. I would argue those sources of resilience, we didn't have before. And if there is going to be a time that we avoid a recession, it's probably this time.

MH: So that’s a good thing right?  Well, maybe. By skirting a recession, it can be easy to think the economy is a) hot and b) healthy. There’s still labour demand, and consumer spending is high. 

But that’s probably an illusion. And the reasons for our resilient economy might actually be detrimental to the long-term prosperity of Canadians. 

Musical interlude

MH: Let’s start with the job market.  According to Walid, there are two reasons for a hot labour economy. First, 

WH: for the most part, a hot labor market means that the demand for jobs is greater than the supply of jobs. 

MH: And second, 

WH: There is a situation where that could just be a mismatch of skills. In other words, it might be the case that we have the economy operating normally. It's not hot, it's not cold, it's just acting normally. But you can't find the skills that you need. 

MH: In Canada, post pandemic, Walid believes that it’s probably a combination of both – there was a lot more demand than labour supply, but the dearth of talent was also driven by a number of people in the market re-thinking career paths, creating a mismatch in skills and demand.

When we add in the growing number of immigrants, that can create a problem. 

WH: Canada is a country of immigrants. And so many people come to Canada, and they're highly educated and skilled - doctors, lawyers, nurses, accountants, engineers, and they get here only to find they can't practice their trade.

MH: In August, even though nearly 20,000 jobs were created, our unemployment rate jumped to 5.5 per cent from a low of 5 per cent just a few months earlier, which some economist attribute to our population growth outstripping job demand. 

WH: Increasing Canada’s population by a million people in one year, that’s going to increase the size of the economy. But it ain’t going to increase prosperity if these new Canadians are not able to be more productive than the Canadians that were here before them.

MH: The second reason our recession resilience might be a cause of concern comes down to the government’s ability to pay back the stimulus money it spent. 

WH: Now, the Canadian government added $350 billion to our debt. That’s a lot of money. So our debt went from $700 billion to over a trillion, and we have to pay that back. That means the government has to take $30 billion of our tax revenue, and not use it to pay for health care, or education or infrastructure they have to pay interest on the debt

MH: Effectively, Canada runs the risk of losing sight of long-term growth as it faces short-term problems. 

WH: It really should be an opportunity for governments to recalibrate, to think about the long term. Unfortunately, given the political environment in Canada, we don't see any of that. So I would say the pandemic and the recession really took the government's eye off of a really important issue, this is a, long standing decline in Canada's prosperity relative to our trading partners but this made it worse.

Musical interlude 

MH: When Canada celebrated its 100th anniversary in 1967, Canadians were the third wealthiest by household globally. Today, about 50 years later, we’ve dropped to 15th.  

WH: And when you adjust for cost of living, that's called P P P or purchasing power parity, we're about 30 per cent lower than our American cousins, which means if you work in Canada, if you have a similar job in the US, that US job is going to pay you 30 per cent more in terms of what you can buy with it.

MH: And, as we look at repaying our debts and creating a prosperous economy, that’s a problem. 

WH: The wrong way to raise this tax revenue is by raising tax rates. The right way to raise tax revenues is to create a more productive and a more innovative economy. Because if I can make you more productive, if I can get your income to rise by 30%, because you're more productive, then I could lower the tax rate on you, but still earn the same tax revenue.

MH: To do that, Canada needs to fundamentally change a few things 

WH: We need to create a more innovative environment. So we're not working long, long hours, but earning low income. We need to diversify our economy, not only into different sectors, but also within sectors, but to do more high value activity. 

MH: Walid has a lot of suggestions – he’s written an entire book about the topic - though he does have a few areas on which he believes the government should focus. 

WH: Number one is all of this protectionism, smothers innovation and productivity. 

MH: When we’re protectionist, industries can be profitable without competition, and competition is largely what breeds innovation. 

Secondly, Walid hopes governments ease the burdens of credentialing for new immigrants. 

WH: When immigrants are not allowed to practice their trade, which truly they're trained for. It's not just the immigrants that lose. All Canadians lose. Shortage of doctors, shortage of nurses. We have all of this talent within our midst, but all of these obstacles are in the way.

MH: Finally, Walid knows bureaucracy has its uses and is important, but  it can be stifling in an environment trying to encourage innovation. 

WH: Most of our trading partners have these numbers as a share of GDP that are growing except Canada. Canada's is falling and flat. If you look at the World Economic Forum, they do a survey of business leaders, about what's the most difficult thing about operating in each economy in the world. And in Canada, the number one obstacle, or pain point to operating in Canada, by businesses, is dealing with an inefficient government bureaucracy.

It's just that Governments need to eliminate all of that bureaucracy that's only there to impede business and doesn't serve the purposes. Governments have the subsidies for R&D, but they're too hard to get. Why?

MH: Ultimately, Walid believes the only way Canada can achieve a path to healthy economic growth is with bold leadership. 

WH: I wish policymakers would take these issues more seriously, and sit there and say, “Wow, other countries are surpassing us. Not in size, but in prosperity. What are we doing wrong?” Study after study after study after study has told the government what they're doing wrong, and they won't change it.

Bold leadership is thinking about what's best for Canada's future when it comes to prosperity, and implementing the policies despite  the opposition or pushback they get from special interest.

Without that bold leadership, a lot can change in 50 years.  What kind of a country are we going to leave to our children?

Musical interlude

MH: This has been Rotman Executive Summary, a podcast bringing you the latest insights and innovative thinking from Canada's leading business school.  

Special thanks to Professor Walid Hejazi. Join us next month as we chat with Professor Francesco Bova about why businesses need to jump on the quantum computing train sooner rather than later. 

This episode was written and produced by Megan Haynes. It was recorded by Dan Mazzotta and edited by Avery Moore Kloss.   

For more innovative thinking, head over to the Rotman Insights Hub, and subscribe to this podcast on Spotify, Apple or Google Podcasts. 

Thanks for tuning in.