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November 3, 2003

Presentation by the Honourable John Manley, P.C., M.P. to the House of Commons Standing Committee on Finance

Ottawa, Ontario

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Introduction

Good morning. Thank you, Madam Chair and all members of the committee, for inviting me today to provide an update on Canada's economic and fiscal situation.

Let me start by saying that my appearance here before the committee today has special significance for me, and for my government. Tomorrow marks the 10th anniversary of our government. Ten years ago Canadians invested in us their hopes and aspirations for a better life-for themselves, for their communities and for Canada.

I probably don't have to remind you of the economic situation that we found when we assumed office. Ten years ago Canada was in the grip of a fiscal crisis. We faced an annual deficit of $38 billion and a crushing debt burden. Our federal debt equalled two-thirds of our nation's total annual economic output and was devouring more than 35 cents of every tax dollar, simply to pay interest. The Wall Street Journal called Canada "an honorary member of the Third World." And there was real concern that the International Monetary Fund (IMF) would have to step in to stabilize our financial situation.

That was then.

Ten years later, through the hard work and sacrifice of Canadians and a commitment to sound fiscal management, we have turned things around. We have put an end to 27 years of deficits and we have significantly reduced Canada's debt. The federal government has succeeded in keeping the annual inflation rate low-within the target band of 1 to 3 per cent. We have actively pursued freer and fairer trade. We have made smart investments in innovation and skills development and in key areas such as health and poverty reduction. We have renewed our commitment to improving accountability and transparency in the management of public resources. We have reduced taxes by $100 billion-the largest personal and corporate tax cuts in Canadian history.

Our ongoing review and reallocation exercise represents the beginning of a culture change in the public service. We will eliminate programs that don't work. We will adjust programs to new realities. We will align our programs to the changing priorities of Canadians. We will be prudent in our spending.

There are many reasons that our surplus last year was higher than projected. But one reason was that our program spending was lower than budgeted. That's a good sign and a portent for the future. Prudence, rigour, spending aligned with priorities are part of this government's commitment.

And the result, I think, is clear. Today Canada is among the economic and fiscal leaders of the Group of Seven (G-7). We have led the United States and the world's other largest economies in average growth over the last six years. Our debt-to-GDP (gross domestic product) ratio is now the second lowest in the G-7, a remarkable improvement from 10 years ago, when it was the second highest. And we are committed to keeping this ratio on a permanent downward track.

There is no doubt that we had to make some tough choices-and Canadians supported us in our resolve. In 10 short years Canadians have come together to create an economy that is entrepreneurial, resilient and capable of handling adversity at home and abroad-which brings me to the other reason that underscores the special significance of my appearance here today.

I am presenting this economic update to you in a year that has seen a dramatic series of unforeseen challenges affect Canadians and our economy. I think we all know the list: the fires and now floods in British Columbia, mad cow disease (bovine spongiform encephalopathy or BSE), the severe acute respiratory syndrome (SARS) outbreak, the August blackout in Ontario and Hurricane Juan on the East coast.

They all had an impact-on communities, on families and on our daily lives. As a government, we made the decision that we had to be there for Canadians who were put at risk-whether it is SARS or BSE or natural disasters. I am proud of that decision. But add to this weak global growth and the rapid rise in the value of the Canadian dollar, and I think it is fair to say that by any measure, 2003 has been a tough year for the Canadian economy.

And yet, our mettle tested, Canadians continue to be optimistic about the prospects for our economy and, I believe, confident about our future and the future of Canada.

And the world is taking notice. The Economist magazine recently described Canada as, and I quote, "rather cool." The magazine declares that our responsible fiscal management, combined with "a certain boldness" in our social policy, "points to an increasingly self-confident country." And I, for one, agree with this assessment.

Thanks to the determination of Canadians and the economic and fiscal measures taken over the past 10 years, our country has been able to withstand unforeseen shocks. And we are in a position today to take advantage of a global recovery that many economists believe is already underway.

Work Continues

Madam Chair, part of the story behind the relative strength of our economic position can be found in the recent efforts our government has made to help strengthen Canada's economic and fiscal framework.

As I have often said, sound fiscal management means continually reassessing government programs against the needs and priorities of Canadians. It means finding the most cost-effective ways of delivering high-quality services. And it means being accountable to Canadians by being transparent about how their tax dollars are managed and ultimately spent. As we set out in the February budget, we have taken significant steps to meet the demands of sound fiscal management and to improve public confidence.

First, as I mentioned earlier, we have begun the process of making reallocation of public resources an integral part of the way the federal government operates. To that end, the Treasury Board is leading a systematic and ongoing examination of all non-statutory program spending. Last month the President of the Treasury Board announced that this year the reallocation exercise has secured savings of $1 billion. And this is just the beginning. Canadians can expect to see even greater savings in the years to come, as the federal government continues to do a better job at moving resources from lower to higher priorities. This is not a one-time exercise, and we will get better at it. We will continue to strengthen our commitment to sound fiscal management by ensuring that reallocation remains a permanent feature of the way we manage the fiscal affairs of Canadians.

Second, we have taken important steps toward honouring our commitment to create a new rate-setting mechanism for employment insurance premiums. Consultations on this issue wrapped up this summer, and our goal now is to bring in legislation next year to establish a permanent rate-setting regime for 2005 and beyond.

Third, we are continuing our efforts to encourage reform in Canada's system of securities regulation to ensure that it promotes competitiveness, innovation and growth. Last March we established an independent panel of highly respected Canadians to review this issue. Their report is expected by the end of this month. This report will provide recommendations that all governments and stakeholders will be asked to consider to ensure that Canada's role in global capital markets remains strong.

In other areas of government business, we are pursuing our discussions with provincial and territorial governments on renewing the equalization and Territorial Formula Financing programs. As you know, these programs are vital to securing the well-being of millions of Canadians. Together with the provinces, we are working to improve the stability, predictability and integrity of equalization funding. We have made real progress on key issues. Our government will work to complete the renewal process by the end of March 2004.

Also, last June the Government set out its response to the report prepared by this committee on bank mergers. In our response, building on the important work of this committee and the Senate Committee on Banking, Trade and Commerce, we clarified public interest considerations in reviewing bank merger proposals. We also explored other significant issues affecting the structure of the financial services industry as a whole. Public input on these issues is currently being received, and the Government is committed to delivering a new policy in June 2004.

All of these issues are important public policy matters. As always, they will require some difficult choices. But as the events of the past year have shown, we must be prepared to make these decisions to preserve our strong fiscal position, to continue to build confidence and to confront an increasingly competitive global economy.

Global Economic Developments

Let me turn now to the global economic picture. From a global perspective, 2003 has generally been a disappointing year. World growth remains unbalanced, with domestic demand in advanced nations outside North America generally quite weak.

The euro zone, which includes the 12 countries that use the euro currency, has seen another sluggish year. Germany, Europe's largest economy, barely saw any economic growth in 2002, and is not expected to grow at all this year. Most European countries have large fiscal deficits as well. In the period ahead the significant and protracted weakness in domestic demand in the euro zone is expected to continue.

Japan has experienced six consecutive quarters of growth, led by strong exports. However, domestic demand remains weak and consumer spending is essentially flat.

But as always, the country that looms largest on our economic horizon is the United States. The last two quarters suggest that a robust U.S. economic recovery is at last unfolding. Economic growth picked up in the second quarter, rising by a better-than-expected level of 3.3 per cent. In the third quarter it accelerated further to a very strong 7.2 per cent. Consumer demand and business investment have enjoyed broad-based strength, supported by fiscal stimulus, continued low interest rates and a weaker American dollar. Consumer demand has been particularly strong for big-ticket items such as automobiles and housing. With corporate profits rising in 2003, business investment appears to be picking up, especially investment in software and equipment.

In response to the large and persistent U.S. current account deficits, a broad array of currencies have appreciated against the U.S. dollar this year. These include gains of 11 per cent by the euro, 9 per cent by the yen and 25 per cent by the Australian dollar.

And while a strong fiscal stimulus is contributing to the acceleration of growth in the U.S., at the same time the combined deficit of federal and state governments is forecast to climb to more than 6 per cent of GDP this year. This could adversely affect market confidence.

Canadian Economic Developments

Madam Chair, let me now turn to Canada.

As I mentioned earlier in my presentation, recent developments in the Canadian economy have been dominated by a series of unforeseen challenges. Assessing the economic impacts of these challenges is not easy. Some evidence of the impacts of SARS and BSE can be found in a wide range of economic statistics. For example, the number of visitors to Canada in the second quarter declined by 15 per cent from the first quarter. The export ban on Canadian beef imposed as a result of the single case of BSE led to a 10-per-cent drop in the output of the slaughtering and meat processing industries between April and June. The Ontario electrical blackout and its lingering impact were a significant factor behind a 4.5-per-cent decline in manufacturing shipments and a large decline in real exports and GDP in August. And we continue to assess the impacts of Hurricane Juan, that devastated Atlantic communities, and the forest fires and floods that hit Western Canada.

In addition, the sharp decline in the U.S. dollar has been mirrored by a strong upward surge in the value of our currency. Since the beginning of 2003 the Canadian dollar has risen in value by more than 20 per cent against the U.S. dollar. A higher dollar will affect businesses in Canada, as they adjust to the short-term effect on the profits of exporters and to lower foreign demand for higher-priced Canadian goods and services.

As a result of these shocks, the Canadian economy stalled in the second quarter. In the third quarter, which included the August blackout in Ontario, private sector economists are forecasting a rebound to about 2 per cent real growth.

Canadian job creation numbers reflect our challenges. After very strong job growth last year of more than 500,000 new jobs, employment numbers increased by 98,000 in the first nine months of this year, while the unemployment rate rose slightly to 8 per cent.

At the same time, Canada's inflation rate has declined more rapidly than most analysts had predicted earlier this year. The Consumer Price Index (CPI) inflation rate was 2.2 per cent in September. Core inflation, which excludes the most volatile components of the CPI, was down to 1.7 per cent from over 3 per cent at the beginning of this year.

Slower economic growth and the rapid decline in the rate of inflation have led the Bank of Canada to lower its target interest rate by 50 basis points since July. These lower rates will help support growth going forward.

Consumer and business confidence in the health of Canada's economy have remained strong. For example, the latest survey done by the Canadian Federation of Independent Business (CFIB) says that confidence among its members has recovered most of the ground lost earlier this year. Furthermore, it also indicates that CFIB members are now more positive about what they expect over the next 12 months.

Global Economic Outlook

Madam Chair, having reviewed where we are at, I would like to turn to where we are going, and our assessments of both the global and Canadian economic outlooks.

First, to the global outlook.

The IMF forecasts that the economies of the world's advanced nations will expand by 1.8 per cent this year, with growth rising to almost 3 per cent in 2004. Next year's forecast represents a significant improvement from the sluggish global economy of recent years.

In the euro zone, however, the short-term outlook remains quite weak. Growth of 0.5 per cent is expected in 2003, rising to 1.9 per cent in 2004.

In Japan, after a modest pickup to 2 per cent in 2003, growth is expected to slow to 1.4 per cent next year as that country deals with continued deflation and with persistent weakness in corporate and financial balance sheets.

In the U.S. the recovery seems to be on a more solid footing. Fiscal stimulus and low interest rates continue to support U.S. consumer demand. This, along with improved corporate profitability, will give firms the confidence and the means to invest and create new jobs. The decline in the value of the U.S. dollar will help fuel their recovery by making American exports more attractive.

Private sector economists have raised their forecast for U.S. growth in 2003 to 2.7 per cent and have also revised their growth forecast upward to 3.9 per cent for 2004. A strong U.S. economy is obviously good news for the world economy and for Canada in particular.

Canadian Economic Outlook

Madam Chair, let me now turn to the economic outlook for Canada.

The Department of Finance regularly surveys a group of private sector economists to get their views on Canada's economy. In the most recent survey, conducted in September, economists lowered their estimate of 2003 GDP growth to 1.9 per cent, down from the 2.2 per cent they forecast in June and the 3.2 per cent they anticipated at the time of the February 2003 budget.

However, private sector economists believe that a variety of factors should lead to an increase in economic growth over the balance of 2003 and through next year. These factors include continued strong U.S. growth, recent interest rate reductions by the Bank of Canada and a return to more normal output levels.

Historically low interest rates will support consumer spending and business investment. The Conference Board of Canada's Index of Business Confidence supports this view. It showed a strong rebound in the third quarter, with a large increase in the proportion of firms who expected economic conditions to improve in the next six months and who thought that now was a good time to invest.

Private sector economists now forecast real growth in Canada of 3 per cent in 2004. This is down from the 3.5-per-cent projection at the time of the February budget. The economists believe that the trade and other adjustments resulting from the rapid appreciation of the Canadian dollar will continue into next year. This is the main reason they have lowered their Canadian growth forecasts, even as they have revised upward growth estimates in the U.S.

It is also worth noting that the private sector economists we have surveyed expect Canadian economic growth to average about 3 per cent for the four years after 2004. This is largely unchanged from what was anticipated at the time of the February budget.

Reasons for Caution

Madam Chair, I am happy to say that these economic forecasts point to an improving picture for both the Canadian and global economies. But we must remain prudent. There are a number of uncertainties that could affect these forecasts in the months ahead.

First is the sustainability of the U.S. economic recovery. In the short term it depends upon a return to job growth. Without this, consumer demand could weaken, and investment would slow as companies lose faith in the durability of the recovery. As well, the growing U.S. fiscal imbalance will need to be addressed, or the rapidly rising debt could put upward pressure on world interest rates.

Second, private sector economists are of the view that a significant downside risk to the Canadian outlook is the impact of the appreciation of our dollar on the economy. Because of the extent and speed of the appreciation of the Canadian dollar, economists have told me that the impact of the appreciation may be greater than they have predicted.

All this being said, on balance Canada's economic fundamentals remain sound, and our economy remains well placed to show sustained growth over the medium term, even in this somewhat uncertain global environment.

Fiscal Progress Continues

Madam Chair, let us now turn to Canada's fiscal situation and outlook.

2002-03

First, I would like to deal with the fiscal results for 2002-03 and put them in an international context.

On October 22, the Government released its audited fiscal results for 2002-03. These results were presented for the first time on the full accrual basis of accounting. This is a major achievement and establishes Canada as a world leader in financial reporting. The Auditor General has strongly endorsed this change, as it presents a more comprehensive picture of the Government's financial position.

The surplus for 2002-03, on a full accrual basis of accounting, was $7.0 billion, marking the sixth consecutive year in which the federal government has been in surplus-something we have not seen in 50 years.

As a result of these surpluses, the federal debt has been reduced by $52.3 billion over the past six years. Let's understand what this means. We are saving $3 billion each year on interest payments that we can spend on other priorities for Canadians. As a result, for the first time in 19 years the federal government spent more on direct transfers to Canadians than we paid for interest on the public debt.

Also, the federal debt-to-GDP ratio has been reduced by nearly 25 percentage points, from its peak of 68.4 per cent in 1995-96 to its current level of 44.2 per cent.

Taking all levels of government together, Canada was the only G-7 country to be in surplus in 2002. Both the IMF and the Organisation for Economic Co-operation and Development estimate that Canada will again be the only major industrial country in surplus this year and next.

Canada's total public debt burden, as a share of the economy, is now the second lowest in the G-7, behind only the United Kingdom. This is a remarkable achievement when you consider that Canada had the second highest public debt burden among G-7 nations as late as the mid-1990s.

Madam Chair, it is important to note the reason behind the better-than-expected fiscal results last year. Budgetary revenues, primarily personal income tax revenues, came in lower than expected. This reflects the weaker-than-expected economy in the first months of this year. However, this was more than offset by lower-than-anticipated program expenses. These were principally attributable to one-time factors. But the weakness in the personal income tax revenues we witnessed toward the end of the 2002-03 fiscal year will carry forward to the current fiscal year.

2003-04

And the fiscal results to date for the current fiscal year confirm this fact. Fiscal results for the April to August period of 2003-04 show a cumulative surplus of $1.3 billion. This is less than half the surplus of $2.8 billion recorded over the same period last year.

Based on these results and private sector forecasts, our estimated surplus this year has been lowered to $3.5 billion, down from $4 billion estimated in the February budget. As you will recall, this $4 billion included $3 billion of Contingency Reserve and $1 billion of additional economic prudence.

As I mentioned earlier, Canada has been faced this year with a series of unforeseen challenges that have required the federal government to act. Since the February budget we have announced $1.2 billion in new spending this year to meet these challenges. This includes measures to assist those Canadians most affected by SARS and BSE. It also includes additional spending on our international obligations, including support for the role our troops are playing in Afghanistan.

After taking into account the cost of these measures, this leaves us with an estimated budgetary surplus of $2.3 billion for 2003-04. This means there is $2.3 billion left in what was a $3-billion Contingency Reserve to ensure that we meet our commitment to achieve a balanced budget.

Madam Chair, last February the Prime Minister and the provincial premiers and territorial leaders reached a historic accord on health. As part of this accord, the Prime Minister agreed to transfer up to an additional $2 billion, provided the federal surplus was more than the $3-billion Contingency Reserve this fiscal year. Notwithstanding the conditional nature of this agreement, we now know that many provinces have already earmarked this money for spending on health care.

As we have seen, the revised fiscal projections suggest that it is unlikely that the federal government will see a surplus of more than the $3-billion Contingency Reserve this year. Despite this fact, the Prime Minister has written to the provincial premiers and territorial leaders today to inform them that, if there is any federal surplus this year, we will provide up to the first $2 billion of it for health care spending when we close the books. This is an important decision-one that addresses a top priority for Canadians, while promoting the spirit of co-operation that is central to the accord on health.

Let me stress again, we will not run a deficit this year. Our commitment to balancing Canada's books remains the cornerstone of our fiscal planning.

Madam Chair, this is a one-time change of policy in regard to the Contingency Reserve. Reducing Canada's overall indebtedness continues to be an important priority for the federal government moving forward. But Canadians expect us to make responsible, prudent choices when dealing with unforeseen circumstances. We are doing that this year.

2004-05 to 2008-09

I would now like to turn to the medium-term fiscal outlook. But before doing so, allow me to remind committee members of how these projections were arrived at.

The Department of Finance surveys private sector economists every quarter and uses their average economic forecasts as the basis for our fiscal planning. For this Update, four macroeconomic modelling firms used these forecasts to generate fiscal projections for the next five years.

Over this period, before making any allocation for prudence, the average private sector projections forecast a surplus of $3.0 billion in both 2004-05 and 2005-06, $4.0 billion for 2006-07, $6.0 billion for 2007-08 and $9.5 billion for 2008-09. These figures include the cost of measures announced since the February budget.

Madam Chair, the figures I have just outlined show that in the short term Canada faces a period of relatively modest fiscal surpluses as we deal with a weaker economic outlook. These surpluses will allow us to set aside the normal $3-billion Contingency Reserve every year. However, there will be no additional economic prudence until the third year of the forecast period.

The reason for this is quite simple. While private sector economists have substantially lowered their forecast for economic growth this year and next, they have not changed their views about the growth prospects over the medium term. This means the loss of production and income resulting from weaker growth this year and next is not expected to be made up by stronger growth in the near future. This, in turn, means that national income-the broadest measure of the Government's tax base-is expected to be lower throughout the five-year projection period than the economists anticipated at the time of the February budget.

Madam Chair, I believe this underscores the importance that we must place on our annual reallocation efforts. These efforts will be crucial if we are to continue to be able to address the highest priorities of Canadians and respond effectively to unforeseen shocks, as we have this year. We must strive to restore our normal prudence as soon as possible. And we must continue to find savings by improving the way the federal government manages and spends taxpayers' dollars.

Nevertheless, it should be remembered that without the fiscal discipline of the last several years, we would be facing a real deficit situation and a return to a growing national debt-a burden that would continue to weigh even more heavily on future generations. And over the long term I believe this would pose the single biggest threat to our ability to spend on the programs that Canadians want and need.

Thankfully, that is not the case today. In fact, our national finances remain in the black and are forecast to do so in the foreseeable future. We are the only G-7 country in that position. This Canadian advantage is a direct result of the progress we have made over the past 10 years to put Canada's finances back on track and keep them there.

A Decade of Progress

Madam Chair, 10 years ago Canadians elected a new government. They entrusted us to take the actions that were needed to provide a better future for themselves and their children.

Together, Canadians have come a long way. We can take great pride in the progress we have made-progress achieved through the determination, hard work and dedication of Canadians across our country.

But to fully appreciate how far we have come as a country, we need to remember where we were 10 years ago. As I mentioned earlier, 10 years ago our economy was in crisis. Our government inherited a disastrous economic situation-high unemployment, low growth, high deficits and low confidence. A decade ago it was virtually impossible to imagine how our nation might come so far, so fast.

Who honestly believed that within 10 years we could erase an annual budgetary deficit of $38 billion, produce six consecutive surpluses and reduce our net debt by more than $50 billion?

Who thought we would have been able to implement a five-year $100-billion tax cut plan, amounting to the largest cuts in Canada's history?

Who thought our corporate tax rates would be lower, on average, today than those in the United States? This is an important element in attracting new investment to Canada, which helps create jobs and fuels economic growth.

Who believed that we would be able to commit to substantial increases in the National Child Benefit, boosting funding for kids by more than $5 billion by 2007 and helping to reduce the number of Canadian children living in poverty?

Who would have conceived that we would be able to place the Canada Pension Plan on a sound financial footing for the next 50 years-thereby guaranteeing that the current and future generations of working Canadians will be provided with the means to live in comfort and dignity when they retire?

Who thought we would see record job growth and economic expansion to the point that today there are 3 million more people working in Canada than in 1993?

Who would have forecast that, over the past six years, Canada's GDP per capita, which represents the best measurement of a nation's standard of living, would grow by 20 per cent? This is the fastest level of growth in the G-7.

Who would have predicted that we could invest an additional $63 billion to strengthen our health care system based on accords with the provinces and territories?

Who dared to think that by now Canada would have seen the largest investment ever-$13 billion-in research and innovation, turning Canadian universities into world leaders in the pursuit of knowledge, new ideas and development of cutting-edge technology?

All that, and much more, Canadians have achieved in 10 short years. Yes, we called upon Canadians to make sacrifices. And it was painful for people who felt the impact of cuts as we came to terms with our financial situation. As the then Minister of Industry, I had to cut my budget by 50 per cent, in the process laying off hundreds of excellent public servants, many of whom lived in my community here in the national capital. I know first-hand the sacrifices that people made.

But the bottom line is clear-the Canada that we know today is a very different and much better place in which to live, work and invest. It is a Canada that is rapidly shedding the burdens of the past and is poised to take full advantage of the opportunities of the future.

Certainly, there are still major issues we must tackle and pressing needs that must be addressed. Our work is not finished. There remains much to do if we are going to build a more innovative, more intelligent, more inclusive and more international Canada for our children and grandchildren.

Still, we can be certain that the fiscal path we are on is the right one. It has taken us far. And it will take us even further as we build an even better Canada for all Canadians.

Conclusion

Madam Chair, this has been a year of trial and tribulation. It has tested the resolve of many Canadians from coast to coast.

Despite the shocks we have experienced, Canada's fiscal balance remains intact and our economy is poised to benefit from the general global upswing in the months ahead.

But balance sheets alone don't tell the story of Canada in 2003. I believe the real story is found in the spirit shown by Canadians time and time again this year in the face of crisis. Through the fires, the floods and the blackout, through SARS and BSE, through the ongoing challenges found in farming, forestry and fisheries, Canadians have responded with compassion and resolve.

It is a spirit born of a newfound confidence and driven by a strong sense of purpose and a determination to excel. It is the kind of spirit that allowed us to meet the great economic and fiscal challenges of the last decade. And, Madam Chair, it is the kind of spirit that will make Canada a model of prosperity and security in the 21st century.

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