Q&A: Ken Peacock and David Williams talk inflation, immigration, supply chains—and Canada’s debt problem

The chief economist and VP of policy with the Business Council of B.C. like the pace of the province's economic recovery, but they warn that debt and inflation could spell trouble.

Credit: Business Council of B.C.

The chief economist and VP of policy with the Business Council of B.C. like the pace of the province’s economic recovery, but they warn that debt and inflation could spell trouble

There’s an old saying that two heads are better than one. That turned out to be true when we chatted with Ken Peacock and David Williams about the province’s economic prospects.

Peacock is chief economist and senior vice-president with the Business Council of British Columbia, where fellow economist Williams serves as vice-president of policy. Besides sharing their views on inflation, immigration and supply chains, the pair highlighted Canada’s worrying levels of consumer and government debt. They also offered some advice for B.C. businesses looking ahead to 2022 as the pandemic continues.

For the complete interview, check out the The BCBusiness Podcast.

Your recent B.C. economic review and outlook is called Stronger Today, Momentum for Tomorrow. Sounds fairly encouraging.

Ken Peacock: A high-level summary of what we see over the next couple of years: it is fairly encouraging. The global backdrop is strong, but the B.C. economy, in particular, is poised for very strong growth this year. And that’s going to continue into next year, although we have pencilled in some expectation of a moderation in the pace of expansion next year.

If someone told me I’d be writing up an economic forecast report that suggested that the B.C. economy would be firing in almost all cylinders by mid-2020, I would have said that’s unlikely. So it’s turned out to be much better than we would have expected a year ago.

The Bank of Canada forecasts that global GDP growth will be close to 7 percent this year, then fall to 4.4% in 2022 and to 3.2% in 2023. Where does Canada fit into the big picture?

David Williams: Canada’s doing pretty well, and a reason for that is the big ramp-up in vaccinations that took place in the second quarter of this year. Canada was a bit of a laggard in the first quarter, and so it looked like we were going to be late to the reopening party that we were seeing in the U.S. and in other countries.

But…we’re one of the world leaders now in vaccination, and that’s allowed a lot more activity to reopen and get back to normal. We still have some restrictions in place and some being reintroduced. But at the same time, businesses and customers have become more adept at operating in this environment. So that’s allowing us to get back to some semblance of normality.

We’ve had a milder recession than in other provinces, largely thanks to large capital projects and our export-focused resources sector. What does that mean for our GDP growth in 2021 and over the next few years?

KP: It puts us in a good position. A theme we tried to tease out in our recent publication is the massive role that these large capital projects played in the provincial economy in 2020. It really is quite remarkable. And the easiest way to do that is to delineate the economy into two segments: the goods-producing sector and the services-producing sector.

The goods-producing sector captures those large capital projects as well as our exports, particularly merchandise exports to other markets. And both those elements were resilient. And in fact, the construction part of large capital projects provided a boost so that the goods industry in B.C. basically didn’t contract. Whereas in all other provinces across the country, the goods component of the economy fell 4, [4.5], 5 percent.

If we turn over to the services side, it turns out B.C.’s economy was basically as hard-hit as all other provinces. So the real differentiator is these large capital projects—LNG, BC Hydro’s Site C—and then our natural resource–based exports. So it’s put us in a good position.

To circle back to your question, I think that sets us up to do fairly well in 2021. That momentum continues. Yes, some of the export steam or momentum will slow in the year ahead, but it puts us in a good place. And these large capital projects are going to continue to provide a lift right through this year and into 2022 as well.

LISTEN: Ken Peacock and David Williams on the BCBusiness Podcast

What about the labour situation? Across the country, we’ve seen labour demand recover to or surpass pre-pandemic levels, but unemployment is still too high. At the same time, Canada is planning to welcome about 400,000 new immigrants this year, the largest number since 1913. As you point out, the timing is a bit odd. What’s going on there?

DW: It’s a really strange decision from the federal government. What they’ve effectively done is move the goalposts on a labour market recovery. As you pointed out, if you look at hours worked, labour demand is back to where it was pre-pandemic. If you’re in the hospitality sector, it’s still pretty hard going. But in a lot of other sectors, we’re either at or above where we were before the pandemic.

So you would think the unemployment rate would have come back down to its pre-pandemic level. But as you pointed out, we are ramping up labour supply at a time when labour demand is struggling to recover. It’s not something you would normally do.

So as a result, you have lots of unemployment, and the people who are bearing the brunt of that are newcomers themselves. And I’m a newcomer to this country as well. The unemployment rate among immigrants of less than 10 years is 10 percent. It was double that at the peak of the pandemic. So it’s setting up people for a very tough beginning to Canada and setting up for a lot more unemployment across the board.

How is the provincial labour market doing? Which sectors are thriving, and which ones remain weak?

KP: One of the very interesting things about this recession is, it’s clearly not all negative. Yes, some sectors were very, very hard-hit, and everybody knows the story. Air transportation, international tourism, the hospitality industry generally. But some sectors grew quite significantly.

What really stands out that probably won’t be too much of a surprise is that whole computer services/data transfer/information—the technology we’re using right now to communicate virtually. The number of people working in that space—if I could call it, collectively, professional and technical and scientific services—is up 20 percent year-over-year. This is a massive, massive increase.

So the labour market has proved to be very dynamic. Yes, there’s pockets of pain, but there’s also these areas that have expanded quite substantially. And I think the varied performance across sectors is some of the reason that we’re getting these strange labour market results and indications, with some employers saying they’re having a terrible time hiring people. At the same time, the unemployment rate remains higher than it was prior to the pandemic, so there’s still a bit of an issue with the number of people. But very, very strong demand in some industries.

The BC Tech Association has called for better economic data to measure the impact of the technology sector, which is currently lumped in with professional, scientific and technical services. At the same time, there’s limited provincial data on services exports. How important do you think it is that we make some changes there?

DW: This is something that statistical agencies around the world are grappling with: technological change, the importance of intangible assets and the rise of the technology sector and its impact across sectors throughout the economy.

One thing I would say is that it’s important to keep things in perspective. If we had a lot of productivity growth that we just weren’t seeing in the official statistics, then you would be seeing it in all countries in the official statistics. And we’re not. What we see is Canada lagging very badly behind other countries. The same measurement issues across countries, but Canada lags very badly on a lot of indicators for innovation and for investment intensity.

The second point is that if we were seeing a lot of innovation that wasn’t being measured, then you would say, OK, we’ve got a lot of productivity out there that’s not being captured in our official statistics, so we must be seeing an awful lot of real-wage growth out there. And we’re not. If we were generating a tremendous amount of productivity increases, we would be seeing real-wage growth very, very strong, and that’s not what we see. We have been seeing very, very meagre real-wage gains over the past decade or more, which really does line up pretty well with our productivity growth performance. So I think you’ve got to take the measurement argument with a grain of salt.

KP: If people are looking to improve measurement of service exports and services in general, and better quantify [them] in the hope that it will reveal the industry as a whole bunch larger, I don’t think that’s a sound argument for suggesting that we need to expand our measuring capacity in that sector. But if the reasoning is, it’s important to get a better sense of the size of the sector, the impact, exactly what we’re exporting, and to help inform policy, absolutely. But if there’s some sort of hope that there’s a little magic pool of unmeasured activity out there that we’re going to find, I don’t think that’s a good reason.

READ MORE: The B.C. economy has fundamentally changed. Are we ready for tomorrow?

What about the argument that we’ve moved on from being a resources-based economy to a knowledge economy—that most of our economic activity now is services?

DW: A lot of those services jobs that you’re talking about, they’re serving goods producers, but the activity is being captured in professional services. The goods sector is really the big driver of growth in the economy. If you look at the productivity statistics by industry, Canada’s productivity is around $56 per hour worked. That might be a year or two out of date now; it might be a few dollars different. Most of the services sectors are producing about that or a little above that. I think some of the IT sectors are producing more like $80 per hour.

But if you look at something like natural resources, the value added per hour worked in those sectors—because of the amount of capital equipment, the amount of technology, the amount of scale that’s involved in that production—it’s more like $300 an hour. In oil and gas, it’s more like $1,200 an hour. I mean, these are tremendously highly value-added industries that we’re working in, and they are generating the value creation throughout the rest of the economy and creating demand for those services that we’re talking about.

The second point is that you don’t have to take our word for it: look what customers are buying. So if you look at Canada’s export mix, you’ll see that natural resources and manufacturing make up about two-thirds of everything that the rest of the world wants to buy from us. That’s sending a pretty strong signal about where Canada’s competitive advantages lie.

KP: No doubt about it, the services are where a lot of the growth is. But a few things to note. It’s quite remarkable if you look at the value of output and the value of merchandise exports, tangible items that we sell to other jurisdictions. It’s been remarkably stable over the past two decades. Yes, there’s economic cycles and commodities cycles baked into it, but it’s been stable and trending upward for two decades.

The reason that goods represent a smaller share of the economy is not because the goods industry itself is shrinking. Quite the opposite—it continues to expand. But the pace of growth in services outstrips that in goods. So services just become a bigger component of the economy over time. People are aware of that; most people they know work in the services industry.

The other interesting thing to note: if we look at our export profile—of merchandise only, not services—80 percent of our merchandise continue to be resource-based….If we’re trying to expand and grow and improve prosperity in the province, we should consider growing our export base and ask ourselves, What are we good at? We should focus on what we’re good at in British Columbia, and we do have a big advantage in our resource endowment, our resource wealth. And we’re really good at extracting [it] in environmentally friendly and sustainable ways, and the benefits of this are very widespread across the economy.

How big a threat is inflation to the recovery?

DW: I don’t think anyone was expecting inflation to be as high as it currently is. I think some of that is base effects because we had very low inflation in the early stages of the pandemic. Some of them are temporary supply issues and supply chain issues due to temporary closures, reopening, shortages of parts. And there is a hope that this is all benign and that it’s just a temporary phenomenon, and then by next year, inflation will start moving back toward 2 percent.

There’s a couple of concerns around that. One is that those supply chain issues that we’re talking about, they’re not temporary, they’re ongoing. There’s something happening over here, and there’s something happening over there. And they continue to cascade through the economy, because of COVID but also because of efforts at decarbonization and realignment of supply chains in a post-COVID world, reshoring—lots of decisions that add costs and delays into the supply chain. And that might not be as temporary as we hoped.

The second aspect is inflation expectations. We’ve gotten so used to having inflation at 2 percent or less for so long that people start looking at what recently inflation has been and start thinking, Hey, I’m not going to accept a 2-percent pay rise next year because inflation last year was 3. So I want a 3-percent pay rise next year.

If those sort of expectations come to fruition, then as the economy gets back toward full employment, you’ve got supply chain issues and you’ve got expectations of higher inflation, and you’ve got rising demand and diminished slack in the economy, all of these factors might lead to inflation being more persistent.

What other risks could cloud the economic outlook for B.C. this year and next?

DW: Globally, inflation is picking up. In the U.S., inflation is well above 3 percent. So if we’re getting these price rises, and if central banks, including Canada’s, have to increase interest rates to try to tamp down demand and slow down the inflation dragon, it’s going to be really difficult for a country like Canada that’s painted itself into a corner with its indebtedness.

Going into the crisis, Canada was the seventh-most-indebted country in the world in terms of its total debt to GDP. We’re now the sixth. The household sector is particularly indebted. We’re the fifth-most-indebted household sector in the world; most of that’s mortgage debt. We have the 13th-most-indebted corporate sector in the world; we were 14th before the crisis. And we have the 11th-most-indebted government sector in the world; we were 13th before the crisis.

So we’re currently carrying around a bit over three-and-a-half times GDP as debt. That’s going to be awfully difficult to manage if Canada’s central bank and other central banks around the world start raising the cost of carrying that debt. And that will make it hard to tamp down inflation without sparking off some sort of economic or financial crisis. So I think it’s going to be a very, very tricky Houdini escape from some of these challenges.

KP: Higher interest rates will have big impacts. I would focus the concern even a little bit more on the housing sector. As people know well in this region, a lot of people have to take on very high mortgages to be able to purchase a house. Rising rates is something that would definitely be a concern and weigh heavily on households and consumer spending if the cost of carrying these mortgages rises substantially. I would highlight that as the single biggest risk.

Here in B.C., public administration and health-care employment remain quite strong. But in the report, you say that you’re a bit concerned about government spending. Given that we’re in a deficit situation, might that become an issue at some point?

KP: The first thing to say is, B.C.’s provincial deficit, the government’s deficit and the government debt load remain very manageable. And B.C.’s debt load for the government is lower relative to other provinces’, so we’re not in a circumstance that is particularly worrisome.

What we do get concerned about is baking in additional costs—not battling-the-virus costs but permanent additional government spending that over time puts pressure on the deficit. And if we end up in a circumstance where it gets difficult to get the deficit back to down to a low level or even to a balanced budget situation, these add up and they become cumulative over time. And that can be a burden and a drag.

I think this is something that we’re seeing Alberta struggle with right now. They built in a very expensive public sector when they had an abundance of tax revenue from a rapidly growing and expanding energy sector. Now that’s not the case, and they’re struggling with these elevated costs. That’s just something we would caution governments against doing.

DW: The B.C. government’s done a few things [on income support], but most of the heavy lifting’s been done by the federal government. I think the challenge there is, yes, it was important to support people through the pandemic. But given how indebted the country is, how are we going to pay for this and carry this debt going forward, particularly as interest rates rise?

And that’s where you start looking at, what do we get for this spending? There was emergency spending, but there were lots of other types of spending as well. Is that going to raise the productive capacity of the economy. Now, regrettably we didn’t have a federal budget for over two years. And when we did get one this year, it was over 700 pages long, but it was pretty much silent on how to improve the productive capacity of the economy. And ultimately, that’s what’s going to determine whether we can carry the debt loads that we have in this country.

Do you have any advice for businesses, regardless of how big or small they are, looking at the rest of this year and into 2022?

KP: My general advice would be to embrace the reality that the recovery is here and it’s going to be strong for a couple of years. Watch out for debt loads, and expect that interest rates could creep up somewhat sooner than people have been expecting. I think there’s a sense out there that it’s going to be a couple of years before we have to worry about interest rates creeping up. I would build into business operation planning scenarios the chance that rates might begin to creep higher sooner than expected.

DW: We know that businesses did a lot of investing during the pandemic to adapt and to implement new technologies and new business models and new ways of working, which really speaks to the resilience of the Canadian business sector.

The challenge going forward is that we need to become a much more productive country. So governments and businesses have got to be thinking about the incentives around business investment in the country. It’s only with higher levels of business investment per worker that we’re going to be able to pay higher wages to be able to support our extraordinarily high debt loads and be resilient to future economic and financial shocks.