Canada’s biggest risks to economy are internal, OECD warns

Canada’s economy will see moderate growth over the next two years, despite headwinds from Europe and elsewhere, but it faces internal risks from record household debt, lagging business innovation and low productivity, according to the OECD.

The Paris-based Organization for Economic Co-operation and Development said Wednesday Canada “withstood the global economic crisis thanks to a timely macro-economic policy response and a solid banking sector.”

“The economy is continuing to grow despite the persistence of international turbulence, most recently stemming from the eurozone sovereign debt crisis,” the OECD says in a 128-page report.

“The latest indicators suggest the economy is picking up, and the outlook is for continued moderate output growth and inflation in 2012-13.

The OECD, an economic research group with 34 member countries, expects Canada’s economy to grow by nearly 2.2% this year and 2.5% in 2013.

“The fragile U.S. recovery and problems in the euro area, along with the strong Canadian dollar, will limit export growth, although high commodity prices should continue to bolster corporate profits in the energy sector, which — together with the low cost of capital — should support business investment.”

Meanwhile, Canada’s annual inflation rate stood at 2% in April, according to the most recent data from Statistics Canada. The core rate, which strips out volatile items such as some food and energy products, was at 2.1%.

The OECD, however, says subsequent “record-low mortgage rates have pushed house prices up substantially in some cities, and boosted household indebtedness, which poses an increasing risk.”

Household debt “is high and that’s why it’s a concern,” Peter Jarrett, one of the authors of the report, told reporters in Ottawa, following the report’s release.

He acknowledged debt loads have started to ease, but the risks to the economy of any housing market collapse are still “worth worrying about.”

“They’re not trivial and they’re not enormous, they’re somewhere in between,” he said. “Luckily in the last few months they have been moving in the right direction.”

While monetary policy “remains appropriately accommodative given persistent global headwinds,” the OECD warns that policy makers must be ready to act if prices heat up, particularly in the housing market.

The report notes Ottawa has already tightened mortgage-lending rules to help cool sales in the residential sector, given those historically cheap borrowing costs.

But the OECD says that tightening “may have to go further.”

As the federal government wound down its stimulus spending program, launched during the economic downturn, it began looking for ways to cut its record-high deficit. “The 2012 federal budget features significant public spending cuts designed to achieve budget balance by 2015-16. Even larger efforts are being made in some provincial budgets, notably Ontario’s,” the OECD acknowledges.

“This tightening is necessary to reduce the debt overhang resulting from the past recession and stimulus measures, but the authorities should slow the pace of consolidation if significant downside risks to growth materialize.”

Ottawa ended fiscal 2011-12 with a $23.5-billion shortfall, down from the government’s estimates of a $24.9-billion deficit for the year. The deficit for the previous fiscal year was $34.4-billion.

Meanwhile, the OECD places special emphasis on Canada’s productivity, pointing to the disappointingly slow pace of growth in that area.

“While Canada has made great strides in macroeconomic and structural policy settings, and its academic research is world class, the pay-off in terms of business innovation and productivity growth has not been large,” the report says.

“Competitive pressures, which spur innovation, have recently intensified because of the high exchange rate, but further market opening in sheltered sectors like network industries and professional services would be beneficial,” it says.

“Government support to R&D should focus more on sharpening incentives and raising performance.”

Along with a weakening manufacturing sector, the OECD report says Canada’s productivity has been declining since 2002. In the United States, meanwhile, productivity has increased by about 30% in the past 20 years.