As published in The Globe and Mail

As we approach the release of the federal budget, Canada is facing three converging and powerful challenges that require a coherent economic and fiscal strategy from the government.

The first challenge is the return of a political economy on a global scale. From the United States to Europe and Asia, countries are confronted with the challenges of national security and climate change with global competition over technological innovation and investment. By now, everyone has heard of the U.S. Inflation Reduction Act. Few should doubt the threat it poses to Canada’s economic competitiveness.

The second is the sustainability of the government’s current fiscal plan. Fast-rising debt-servicing costs, higher inflation for longer and diminishing fiscal firepower as a result of having doubled our federal debt during the COVID-19 crisis will all challenge the federal government’s inclination to ignore the real consequences of unconstrained spending.

The third challenge – largely a consequence of the first two – is the imperative of long-term growth. Without sustained economic growth, both our current account and federal budget deficits will continue to deteriorate, leading to an inevitable decline in Canadians’ living standards.

There are two main drivers of long-term economic growth. One of them is population growth. The government has taken action on this. Increasing high-skilled immigration is to be applauded, but an aggressive immigration policy will only work if we boost the other driver, productivity, thereby raising wages and living standards. The policy trap here is to confuse raising nominal GDP with GDP per capita, the latter being far more important for our living standards.

Increased productivity – output per worker – is the most important driver of economic growth. Recent experience suggests this is very hard to do. We need to pursue measures that will raise productivity in all sectors. In addition, and this is politically more challenging, we need to focus on expanding the sectors that hold the most promise for raising Canada’s productivity.

A country’s industrial composition matters a great deal. Certain sectors generate significantly higher output per employee and can increase productivity at a faster rate. Advanced industries are key to this goal. These sectors combine significant R&D investmentand a highly qualified work force.

Sectors that invest heavily in technology and innovation tend to be more productive than others. A country with an advanced manufacturing base using artificial intelligence, robotics, genomic medicine and advanced computation will yield significant productivity gains. This is where the new frontiers of economic competitiveness are being drawn. The political economy of semiconductors fabrication is not the same as the one for manufacturing shoes or T-shirts. One is being developed hastily, the other not so much.

Canada has a significant structural current account deficit in advanced industries, signalling a weakening of our economic competitiveness. It indicates we are not able to generate sufficient income from high-value exports to pay for our imports of advanced goods.

Canada can compete in advanced industries. We should be proud of our Canadian global champions in aerospace, agrifood, energy and automotive, all advanced industries. The problem is we don’t have enough of them.

British cabinet minister Michael Gove stated in a recent speech: “Rather than being an entrepôt, a bazaar and a duty-free exchange, a strong economy must also make, manufacture, create, innovate and shape.” He was referring to the British economy, but this applies just as much to Canada.

This is where modern industrial policy comes into play. It is a high-stakes game because politicians will often use industrial policy to justify all kinds of government interventions that have proven to be ineffective. As former U.S. Treasury secretary Larry Summers observed: “I like industrial policy advisers how I like generals. The best generals are the ones who hate war the most but are willing to fight when needed. What I worry about is the people who do industrial policy love doing industrial policy.”

Targeted policy design and execution are paramount. We need to mobilize our human capital, create a modern science and technology architecture capable of converting intellectual capital into expanding our advanced industries and high-tech manufacturing, build proper transmission channels of public R&D to industry and create a regulatory and tax environment conducive to capital formation. In the current circumstance, the worst policy decision would be to take the easy road of spreading subsidies across sectors and all regions of the country.

Getting to the right policy outcomes is more important than political expediency. Addressing these challenges will require policy work that will go well beyond one budget.