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Chapter 3
Challenges and Opportunities
The combination of emerging economic giants and widespread technology adoption is profoundly reordering the global economy. As a consequence, Canadian firms have unprecedented opportunities to penetrate massive new consumer markets and secure positions in the higher value-added segments of global supply chains. As we seize these opportunities, we must also address the challenge that our aging population poses for our economic and fiscal prospects.
For Canada to respond, all Canadians must be able to realize their full human potential. Specifically, everyone should have the opportunity to acquire the necessary education and skills to achieve personal fulfillment through work. No one should face insurmountable barriers or disincentives to work.
This fundamental commitment to fairness must be complemented by an improvement in our productivity performance. There are excellent reasons to be confident in our prospects, including our diverse and highly skilled population, openness to the world, immense resource potential and robust financial health. We can build these advantages further through a consistent economic policy framework that increases education, training and skills, capital accumulation and innovation.
1. An Unprecedented Global Opportunity
The world economy is changing rapidly. Fast-growing emerging economies are increasing their share of global trade and output. Advances in information and communications technologies, lower transportation costs and reduced trade barriers are driving increased global flows of goods, services, capital and people. New business models are emerging, with production increasingly specialized and dispersed across countries. Greater international investment flows are also promoting the rapid spread of new products and knowledge, thereby accelerating economic expansion and increasing competition for skilled workers.
The Growing Importance of Emerging Economies
Emerging economic giants are now major factors in the global economy. The rise of China has been remarkable. Its economy has grown at 9 per cent a year on average for the past two decades and is now the world’s seventh largest.[1] Based on current projections, China is expected to become the world’s second largest economy by 2020, behind only the United States. India’s share of the global economy is also increasing. India has been growing at 6 per cent a year and is now the world’s 12th largest economy. By 2020, it could be the world’s 9th largest, just ahead of Canada.
China and India have also had a dramatic impact on world trade patterns. In 2003 China’s exports surpassed those of Japan, making it the third largest global trader after the United States and Germany. Export growth of Chinese manufacturing goods has averaged almost 20 per cent a year for the past 10 years. While China mostly exports labour-intensive goods such as apparel, textiles, footwear and toys, its exports of office machinery, telecommunications and industrial supplies have also grown rapidly in recent years.
Although India’s share of world trade is still relatively small, its service exports have grown as rapidly as China’s manufacturing exports, though from a much smaller base. Increasingly, India specializes in providing commercial services to Western companies looking to outsource business processes, such as call centres, back-office operations, data entry and computer programming. This dynamic creates cost-saving opportunities for Canadian firms that can then reinvest in higher-value operations here at home.
The pace of the integration of China and India into the world economy mirrors the rise of Japan in the 1960s and 1970s, and that of the newly industrialized Asian economies during the 1970s and 1980s. However, the key difference with China and India is scale. The newly industrialized economies of Asia and Japan accounted for only 4 per cent of the world’s population when they emerged on the world stage. By comparison, China and India together account for almost 40 per cent of the world’s population. While the majority of people in China and India still live in rural areas, tens of millions of new workers are absorbed into urban centres each year. The average skill level is increasing rapidly. For example, China and India together graduate about 400,000 engineers a year. In short, today’s emerging giants have the potential to significantly magnify the impact of similar changes experienced during past decades.
Emerging Asian giants are having a major impact on global commodity markets. To support their rapid growth, China and India have sharply increased their demand for natural resources and related products. China is now the world’s largest user of steel, copper and iron ore, and recently surpassed Japan as the world’s second largest oil consumer, accounting for 8 per cent of world demand. Its effect on the margin and therefore on the global balance of demand and supply is even more dramatic. China accounted for more than 35 per cent of the increase in world oil demand in 2004, more than all countries in the OECD combined. This sharp increase in demand from China not only reflects its rapid growth, but also an oil intensity that is more than double the OECD average. This strong demand for resources and energy has put upward pressure on global commodity prices, particularly oil prices, and is expected to continue to do so in the future. As discussed in the next section, Canada should be a major beneficiary of this growth in demand for natural resources, alternative energy sources and environmental technologies.
Seizing Opportunities in a Dynamic Global Economy
An increasingly dynamic global economic environment provides many opportunities for Canadians. For example, the rise of China and India has increased demand for our exports, particularly natural resources and capital goods. Moreover, the combination of technological advances and these growing markets creates the opportunity to position ourselves in higher value-added parts of global supply chains.
As discussed in the following box, Canada’s resource sector stands to gain immensely. As emerging economies continue to develop, their demand for resources and energy will grow. In addition to providing export opportunities, strong Asian demand for resources and energy puts upward pressure on commodity prices. As a net exporter of resources, this implies a large net wealth gain for Canada.
Canada’s non-resource trade with emerging markets is also increasing. China is the second largest source of our imports after the United States. It has become our fourth largest export market and our exports to China should continue to expand rapidly. Canada’s merchandise exports to China have grown at an average annual rate of 20 per cent since 1999. China now receives 1.6 per cent of Canadian exports, compared to 0.7 per cent in 1999. Moreover, Canadian export growth to China has been slightly faster than that of the United States over this period.
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The Rise of Emerging Economies Bodes Well for Canada’s Resource Sector
Canada’s rich natural resources and the industries they support are a vital part of our economy. This sector—forests, energy, minerals and metals, as well as related industries—accounts for 13 per cent of Canada’s GDP, represents more than 40 per cent of Canadian exports and employs slightly more than 1 million Canadians. More recently energy consolidated its place as Canada’s leading resource export sector. In 2004 energy exports reached a record $66 billion, driven by higher prices and new sources of supply. With rising oil prices in recent years, the share of energy in exports has more than doubled from 7.3 per cent in 1998 to 16.1 per cent in 2004. The Canadian resource sector is very capital-intensive, competitive and innovative. It is a diverse sector, well poised to benefit from a growing world need for alternative sources of energy, environmental technologies and the increasing interest in nuclear energy. Over the past decade, fully one-third of total investment in the Canadian economy has taken place in the natural resource sector, boosting gross capital stock by more than $400 billion since 1994. Over half of this expansion was in oil and gas, including megaprojects such as Hibernia, Terra Nova and Sable Island, and the Alberta oil sands. The non-conventional oil extraction industry, buoyed by prices that help the feasibility of many new projects, is the largest contributor to growth in the mining and oil and gas sector. The level of investment in the oil sands rose from $400 million in 1994 (or less than 4 per cent of investment in conventional projects) to $8.5 billion in 2005 (or 26 per cent of investment in conventional projects). With its abundance and variety of natural resources, Canada is well positioned to take advantage of export opportunities arising from China and India’s development and strong growth. Notably, Canada has a huge recoverable supply of crude oil and natural gas for future development. Crude oil reserves in 2002 were estimated at about 180 billion barrels, consisting of conventional oil (about 5 billion barrels) and oil sands (about 175 billion barrels). Today’s annual oil production in Canada is about 940 million barrels, implying that the proven reserves could last almost 100 years even if the current rate of production were to double. Moreover, the ultimate recoverable potential from the Alberta oil sands is more than 315 billion barrels. The ultimate potential of Canadian natural gas supplies is estimated at nearly 600 trillion cubic feet, enough to last 100 years at current rates of production. |
Nevertheless, Canada has a market share of just over one per cent of total Chinese imports. Similarly, our direct investments in China account for only one per cent of our total stock of investment abroad. We need to make a much bigger and stronger effort to build better economic relationships with China. Canadian firms are well positioned to expand their presence substantially due to our high-quality workforce, diaspora relationships, expanding physical trading networks and sophisticated service industries, which complement our strength in natural resources.
Technology Is Facilitating New Business Models
The combination of technology-driven reductions in transportation and communication costs and lower trade barriers have helped to create new business models, thereby changing the organization of global production and the shape of the international economy. Production processes have become increasingly international and dispersed; countries specialize in particular stages of production according to their comparative advantage. Global supply chains link these processes to deliver final products and after-sale services to the end consumer. Whereas in the past, products were produced and assembled in one particular country before being shipped to the final user, manufactured goods are increasingly being subdivided into many components that are produced in different countries before being assembled (often in yet another country) and shipped to their final destination (see following box). This trend has been reinforced by positive developments in emerging markets that have made the foreign provision of certain goods and services more economically viable.
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Businesses Are Becoming More Globally Integrated
Examples of the "global supply chain" can be found in a wide range of industries, from textiles and toys to computers and telecommunication equipment. In each case, the common principle is to produce the different components of a final product where it is most cost-advantageous to do so. Consider the example of a computer hardware component, such as a video card. The R&D can be performed in Canada, the different inputs manufactured in Korea and the final product assembled in China. The product can then be distributed out of Canada and sold to customers situated around the globe, while the after-sale service can be done in Canada or increasingly in India. The physical location of production matters less now than it did just 10 years ago. What matters is the comparative advantage of the different businesses involved in the global production chain. For Canadian prosperity, it matters that our firms are linked into such chains, particularly in the highest value-added components.
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Increasing Trade in Services
The globalization of trade is now spreading to the largest sector of the economy—the service sector. The same conditions that led to global supply chains for goods are now in place for services, as new technologies have greatly reduced the cost of transmitting data quickly to almost anywhere around the globe. The digitization of information has allowed a broad range of service functions to be performed remotely.
The increasing importance of services in advanced economies has allowed for greater specialization, so that knowledge work has become more modular and can increasingly be divided in multiple tasks to be "assembled" in a final product. Managers and companies have gained the knowledge and experience necessary to make vertical specialization beneficial for a wide range of services.
Through this process, companies are increasingly shifting service-sector activities to where costs are the lowest. Not only are activities being outsourced to other companies domestically, but also parts of the supply chain are increasingly located in other countries, or "offshored" either to an independent foreign firm or to a firm’s foreign-based affiliate. As a result, trade of commercial services has grown rapidly over the past decade. This trend can be expected to continue.
New emerging economies participate in this shift towards the globalization of services. India in particular, with its large pool of English-speaking and well-educated young people, has developed a niche in providing commercial services to companies looking to outsource easily separable information-based business processes. In years to come, similar workforce capacities are expected to come from other emerging economies, such as the Philippines and South Africa.
Increased Importance of Foreign Direct Investment and Skilled Workers
Foreign direct investment (FDI), both inward and outward, promotes the diffusion of new technologies, creates jobs and generates trade. It helps develop supply chains, service foreign customers and make businesses more efficient.
The sharp rise in FDI over the past two decades illustrates the extent to which businesses have become more globally integrated and production more dispersed. Over the past two decades, the world FDI growth rate was more than double that of world trade. The accumulated stock of world FDI nearly tripled in the 1980s and rapid growth continued during the 1990s, reaching US$8 trillion by 2003. Greater international investment flows are supporting the growth of global commercial networks and the rapid spread of new products and knowledge across countries.
Advances in technology and increased openness to trade have made it easier for investment to go anywhere in the world. With the emergence of global supply chains, investment that requires the intensive use of low-skilled labour will flow to a different location than investment that relies on high-skilled, knowledge-intensive workers and specialized infrastructure. These trends will intensify competitive pressures between countries for investment and skilled workers.
Canada must take maximum advantage of the integration of emerging economies into the world economy. In a world in which economic activity is increasingly flexible, divisible and specialized, taking advantage of cost-saving opportunities abroad and strengthening our advantage in high-knowledge activities will be key in order to succeed and attract the best jobs. While we cannot predict the future—in fact, because we cannot—we must continue to improve our ability to adjust to the opportunities provided by a rapidly changing global economic environment. With an open and diverse economy and abundant skilled people and natural resources, Canada is well positioned to take advantage of these opportunities.
2. The Challenge of Population Aging
As the world economy continues to evolve, Canada’s demographic landscape will also change markedly. In particular, baby boomers will soon begin to retire in large numbers. Currently, there are more than five people of working age (15 to 64) in Canada for every person of retirement age (65+). Within the next 15 years, this ratio is projected to fall to four to one, and to be less than two and a half to one by 2050. Population aging will be a major challenge for all industrialized countries and Canada in particular. In fact, Canada is expected to experience the third largest increase in its ratio of elderly to the working-age population among G7 countries over the next 25 years and the sixth largest among OECD countries.
The aging of our population will exert upward pressure on age-related government spending, such as health care and public pensions. The reduction of the public debt burden over the last 10 years and the 1997 reforms to the Canada Pension Plan have positioned Canada well relative to most other G7 countries to cope with emerging demographic pressures. However, more is required to create the economic flexibility needed to address these impending pressures. Most importantly, we need to foster strong economic growth—the primary source of society’s capacity to pay for public services.
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Canada Is One of Few Countries With a Sustainable Public Pension System
The Canada Pension Plan and the Quebec Pension Plan (CPP/QPP), funded through payroll contributions, ensure a basic level of earnings replacement in retirement for all working Canadians. Given the outlook of a growing aged population and proportionately smaller workforce in future years, in 1997 Canada’s federal and provincial governments agreed on a series of reforms to the CPP/QPP system. This package included not only changes to the plan’s financing, achieved through a combination of contribution rate increases, cost savings and a new investment policy, but also significant changes to plan governance and accountability to ensure its ongoing financial health. For example, the CPP Investment Board was created as an arm’s-length body to invest CPP funds, delivering an average nominal rate of return of more than 7 per cent a year over the last five years. According to the 21st Actuarial Report on the Canada Pension Plan released in 2004, the 1997 reforms have ensured the sustainability of the CPP for at least the next 75 years. Canada is one of very few countries with a financially sustainable public pension system. These reforms have therefore helped ensure that future generations of Canadians will avoid disruption in their living standard during retirement. |
However, sustaining strong economic growth in the years to come will in itself pose a major challenge. As the baby boomers retire, smaller cohorts of workers will replace them; the share of the population that is working is projected to decline after 2011. This expected fall in the employment-to-population ratio will exert significant downward pressure on potential growth of living standards in Canada. Over the last eight years, increases in the employment-to-population ratio contributed close to one-half of recorded improvements in Canada’s GDP per capita. This will not be the case in the decades to come. In fact, the projected decline in Canada’s employment-to-population ratio is expected to subtract as much as 0.4 percentage points on average from our future annual growth in real GDP per capita between 2012 and 2030.
To illustrate further the possible direct impact of impending demographic change on Canada’s living standards, consider two scenarios. In the first scenario, we assume that the employment-to-population ratio falls by an average of 0.4 per cent a year after 2011, while productivity continues to grow at the average rate recorded since 1997. This scenario can be thought of as an "aging scenario" with productivity growth remaining at the recent trend of 1.7 per cent per year. In the second scenario, productivity growth increases from 1.7 per cent to 2.8 per cent to maintain growth in living standards at the pace experienced since 1997 despite the fall in the share of the population working. In this latter scenario, living standards would be as much as one-third higher by 2030, or about $20,000 per Canadian in today’s dollars, relative to the aging scenario.
The expected decline in the share of Canadians working is inevitable. To limit the decline, we must ensure that all Canadians who are willing and able to work have the opportunity to do so. Participation in the workforce remains a challenge for a number of Canadians, including Aboriginal people, persons with disabilities, recent immigrants and older workers. Canada’s Aboriginal people and immigrants will be important sources of labour force growth, especially if their employment rates can be raised to the national average. Similarly, the labour force participation of older Canadians, which has increased significantly since the second half of the 1990s, remains below corresponding rates in Japan, the U.S. and most Nordic countries. As discussed in Chapter 4, the challenge will be to increase the labour force participation of these groups to help reach our full economic and social potential.
Increasing Canada’s employment-to-population ratio may help to alleviate the challenge of an aging population, but it will not be a panacea. To illustrate: raising the employment rate of Aboriginal people and immigrants to the national average, while a significant social and economic achievement, would increase Canada’s average GDP per capita by less than 3 per cent and close only about one-sixth of the current Canada-U.S. GDP per capita gap. As we move forward, the demographic challenge facing Canada reaffirms the importance of fostering robust productivity growth to ensure continued improvements in our living standards for years and decades to come.
3. Canada’s Productivity Challenge
To address our changing demographics and seize global opportunities, Canada needs to focus on improving productivity. As discussed in Chapter 1, being more productive means working smarter, not working harder or longer hours (see box entitled "Productivity Growth Improves the Quality of Life in Many Ways" below). A more productive economy creates more and better jobs for Canadians.
In the long run, productivity—defined as total economic output (GDP) per hour worked—remains the fundamental driving force behind living standard improvements. Canada’s economic success in the postwar period was driven by high productivity growth that supported a very rapid increase in the number of jobs and level of wages. Strong productivity growth drives Canadians’ incomes higher; weak productivity growth undermines the economy, reducing the number of jobs and wealth. Over a long period, we can see from Canada’s experience how important productivity growth has been in supporting our living standards. Over the last 50 years, Canada’s GDP per capita has increased more than three-fold, primarily due to productivity growth.
Canada’s productivity performance has improved significantly since 1997. Our average annual productivity growth increased from 1.1 per cent between 1980 and 1996 to 1.7 per cent between 1997 and 2004. Although this turnaround has been impressive, our productivity growth and level still lag behind those of the United States and most other G7 countries (see chart below).
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Furthermore, Canada’s lower productivity level vis-à-vis the United States is not located in a few sectors, but is widespread across industries. As the largest segment of the economy, the service sector contributes the most to our productivity gap with the United States. However, all other major sectors of the Canadian economy, with the exception of construction, are also less productive.
At the economy-wide level, there were periods when Canada outperformed the United States in productivity growth, namely during the 1960s and 1970s. This shows that Canada can match and outperform the most competitive economy in the world in productivity growth.
Building the right conditions for improved productivity performance creates the conditions for more and better jobs. Indeed, Canada’s performance since 1997 provides a good example of how improving the policy environment leads to both higher productivity growth and stronger job creation (see chart below). As discussed in Chapter 2, the combination of strong employment and productivity performance since 1997 has contributed to Canada’s superior performance in living standards growth among all G7 countries. Looking ahead, advances in the inclusiveness of our workforce, the education and mobility of Canadians and strong productivity growth should translate into more Canadians having opportunities for higher-quality and well-paying jobs. The contribution and earnings of skilled workers can also be further enhanced by investments in physical capital and the efficacy of the workplace.
In summary, to meet the challenge of an aging population and to seize opportunities in the new global economy, Canada needs to improve its productivity performance. Higher productivity is not an end in itself but the means by which Canadians will reach a higher quality of life. We need to take greater advantage of the latest technologies, as well as invest more in our people and their skills. This course of action will lay the foundation for continued economic and social progress over decades to come.
The Sources of Productivity Growth
A five-year study by the OECD, The Sources of Economic Growth in OECD Countries, identified greater investment in education, physical capital and innovation as the key factors for creating a higher standard of living.
The performance of individual economies shows that greater investment in any single element, though important, will not ensure strong economic growth. For example, workers with advanced education perform research and development in public and private sector laboratories that produce new ideas. A range of workplace and marketplace innovative activities, and skilled workers, are needed to turn these new ideas into novel products and services, including new machinery and equipment, that enter and succeed in the marketplace.
A successful economy generates new jobs, economic growth and wealth when its performance in each of the elements is strong. Because the sources of growth complement and build on each other, fostering long-term productivity growth requires a policy agenda that encourages both their development and their interaction.
The following chapters discuss the four pillars of the Government’s framework for improving productivity, living standards and prosperity.
"Creating Opportunities for All Canadians" focuses on the first pillar of Canada’s economic prospects—a world-class workforce. Building this capability starts with investments in early childhood development, through post-secondary education, workplace training, and retraining. Even though Canadians are among the most highly skilled workers in the world and currently enjoy a very high employment rate, too many people are still not ready for the high-skill, high-wage jobs of the future. Highly educated workers enable firms to compete and attract foreign investment. Ensuring the active participation of all Canadians in the labour force, including immigrants, people with disabilities, older workers and Canada’s Aboriginal people, becomes increasingly important for meeting the challenges of an aging population.
"Advancing an Innovative Economy" addresses the pressure on firms to be innovators, and to take advantage of global changes and the ever-increasing pace of technological progress. Canada must be a leader in technology development, adoption, adaptation and innovation. We start from a strong foundation in basic research leadership in our universities, which we must maintain. While we have improved our commercialization performance, we must become better at converting public research into business innovation and success. The role of the private sector is central in having an innovative economy, and here Canada’s performance has been mixed. Looking ahead, it will be crucial for the Government to ensure the right conditions exist for Canadian firms to invest more in research and development, innovation and productivity-enhancing machinery and equipment.
"At the Centre of Global Commerce and Networks" takes stock of our current status as a leading trading nation and addresses how we can add to this advantage. The openness of Canada’s marketplace has improved growth and living standards at home. Better global communications networks and transportation infrastructure are increasing competitive pressures on firms, creating new possibilities for trade and investment, and integrating production in global supply chains. Businesses that have a global mindset can benefit from these trends. Our ability to be at the centre of these developments depends on government initiatives to reduce barriers to the flow of goods, investment, ideas and people, to facilitate foreign investment, and to enhance the transportation and communications networks that link Canadians to opportunities in the global marketplace.
"Building the Right Investment Environment" examines the role of government policy in supporting Canada’s economic performance. The strategy responds to the reality that a globally integrated economy enables workers, businesses and investors to move toward regions and countries of their choice. Sound macroeconomic conditions, a fair, competitive and efficient tax system, appropriate regulations, efficient and dependable capital markets and financial institutions, and more productive government will position Canada as a country of choice for individuals, businesses and investors. Our high quality of life, strong social programs, social cohesion, tolerance and cultural diversity all help to secure these advantages.
These rankings of country sizes are based on market exchange rates. While purchasing power parity estimates are best suited for international comparisons of living standards, market exchange rates are more appropriate for assessing the relative importance of a country in the global economy, because they measure the ability of an economy to pay for goods and services from other countries. [Return]
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