The Government's economic strategy, as initially outlined in the November 1984 Agenda for Economic Renewal, has aimed at reversing the deterioration in economic performance since the mid-1970s. To achieve this objective, the Government has focused on two complementary policy thrusts: structural reforms to raise the country's potential output and actions to create the right macroeconomic environment for the economy to realise its potential. Microeconomic reforms have focused on improving productivity performance by reducing economic regulations and distortions, opening access to markets and encouraging and attracting investment. The macroeconomic component of the Agenda has concentrated on curbing, and eventually reducing, inflation and restoring fiscal stability by reducing the budget deficit and reversing the rise in the debt/GDP ratio; by downsizing the government sector through expenditure restraint and privatisation the authorities also intend to create room for the private sector to expand. Specific extensions of the strategy in the February 1991 Budget reflect insufficient progress in achieving some of the Agenda's objectives. They include the setting of specific inflation-reduction targets; reinforcement of public expenditure control; increased emphasis on enhancing productivity and competitiveness; and efforts to improve the balance between monetary and fiscal policies in containing inflation pressures in order to foster domestic saving and investment.
Since 1984, the Government has implemented numerous structural reforms, notably the deregulation of the energy and transportation sectors, the Free Trade Agreement with the United States and an overhaul of the tax system. Measures taken recently or envisaged in the near future, such as financial-sector reforms and the reform of the unemployment-insurance system, are reviewed below and in Part III of the Survey. Including those initiatives, most of the structural-policy agenda set out in 1984 will have been accomplished. None the less, supply-side performance has remained a matter of concern. By international comparison, fixed investment has been high in relation to GDP in recent years; but robust investment has not translated into productivity gains. As noted above, according to revised official estimates, total factor productivity stagnated over the last decade, with no signs of a recovery in the latter part of that period. The Free Trade Agreement and tax reforms are expected to raise total factor productivity growth to about 1/2 per cent per year in the first half of the 1990s, but this would still be a poor performance by international standards. In view of this unsatisfactory outlook, the authorities have commissioned studies to identify the main causes of the country's economic weakness, notably those affecting its ability to compete abroad, and will undertake intensive consultations on policies and actions to improve living standards in the future.
Repeated corrective fiscal action since 1984 has not suffered for the economy to break out of the vicious circle of public deficits and growing debt charges. Reflecting curbs in programme spending and - to a lesser degree - increases in the tax burden, the primary federal-budget balance has improved by 5 1/2 percentage points in relation to GDP and moved into surplus. Due to strongly rising debt charges, the decline in the overall budget deficit, at just over 4 percentage points of GDP, has been more limited, however. With economic growth slowing, the federal budget deficit has been broadly stable since 1989, at around 4 1/2 per cent of GDP. The debt/GDP ratio has continued to rise, exceeding 57 per cent at the end of FY 1990/91. Although the failure to arrest the increase in the debt/GDP ratio can be mechanically attributed to the strong firming in interest rates in the late 1980s, it can be argued that more vigorous fiscal action would have lessened the need for interest rates to rise to curb inflation pressures. As can be seen from Table 6, following a period of marked fiscal tightening, the cyclically-adjusted general-government primary balance moved slightly towards fiscal ease as excess demand rekindled inflation. Consequently, the burden of controlling inflation has fallen mainly on monetary policy, with monetary conditions tightening sharply in 1989-90, as evidenced by the strongly inverted yield curve. Revised fiscal-adjustment plans aim at correcting the imbalance in the policy mix, which should serve to create an environment facilitating easier monetary conditions.
[Tabular Data Omitted]
Notwithstanding the authorities' objective of achieving price stability, inflation performance has not improved since 1984 (Table 6), and inflation expectations have remained firmly entrenched. Considering that the failure of expectations to adjust may have inter alia reflected the absence of a clear definition of price stability and of a precise timetable to achieve it, the Government and the Bank of Canada jointly announced medium-term inflation-reduction targets in conjunction with the February 1991 Budget. The year-on-year increase in the CPI is to come down to 3 per cent by the end of 1992 and to 2 per cent by the end of 1995; the target path after that date remains to be fixed, but the aim would be to make further steady progress towards price stability. While the ultimate target is the overall CPI, for operational purpose monetary policy will focus in the short term on the CPI excluding food and energy. The target rates are regarded as midpoints of a target inflation band with a 1 percentage point margin on either side. None the less, it will be the midpoints that will be the objective of monetary policy, and in the case of deviations of actual inflation from the target rate, monetary or other policy actions will be taken to ensure that the inflation target for the following period is reached. Temporary adjustments will be made to the inflation target in case of large changes in indirect taxes, but - as in the case of food and energy prices - only first-round effects on the price level would be accommodated. The entire target path would be reconsidered only under very unusual circumstances, such as a widespread natural disaster or a large increase in oil prices. Along with other initiatives announced in the latest Budget (such as legislated spending limits, see below), the inflation-reduction targets are expected to help enhance the transparency and credibility of the Government's strategy, thereby reducing the cumulative output gap needed to achieve price stability (the "sacrifice ratio"). Much will depend, however, on how quickly private-sector expectations will turn around, which may be affected by the fact that the largest province has not followed the federal authorities' lead in tightening the fiscal stance.
Tight monetary conditions
Even before the announcement of specific inflation-reduction targets the stated objective of monetary policy had been gradually to eliminate inflation in order to facilitate sustainable growth. The most comprehensive exposition of this position is found in the Central-Bank Governor's January 1988 Hanson lecture, which has been interpreted as a call for zero inflation and prompted a wide debate about the credibility and feasibility of such a goal and the costs of achieving it in terms of output and employment. Research undertaken at the Bank of Canada, which is contradicted by other authors, has produced a relatively low estimate of the "sacrifice ratio" and found no evidence that the costs of disinflation are permanent ("hysteresis") or higher at lower rates of inflation (non-linear Phillips Curve)(4). With progress towards the price-stability goal stalling and mounting evidence of pressure on resources, from 1988 monetary authorities have acted vigorously to put inflation on a downward track. By the traditional indicators monetary conditions have been unusually tight: in 1990, both the real short-term interest rate and the differential between Canadian and U.S. short-term interest rates reached post-war record levels, and the real exchange rate had reached the highest level since the mid-1970s.
As in other Member countries, the conduct of monetary policy has been complicated by the instability in the relationship between monetary aggregates, interest rates, and nominal income as a result of financial-market innovation and integration. In these circumstances, the Bank of Canada has implemented its policy guided by a variety of indicators including nominal demand, monetary and credit aggregates, the exchange rate, wage settlements, and capacity utilisation. Although monetary aggregates are no longer considered to be sufficiently reliable and controllable to serve as formal intermediate targets for monetary policy, they are closely monitored because of their relatively good record as indicators of nominal spending and real activity. In the absence of a sufficiently credible anchor for monetary policy, more attention has been given to the exchange rate. An indicator combining interest rates and the exchange rate is used by the Bank to assess monetary conditions(5). The announced inflation-reduction targets represent a return by the authorities, for the first time since the abandonment of monetary targeting, to a clearly defined medium-term anchor for monetary policy, and to an objective against which the public will be able to assess the results. In deciding on the actions needed to stay on the targeted path for inflation, the Bank will continue, however, to monitor a number of real and financial variables to gauge the strength of the economy and inflation pressures.
Among monetary aggregates, the behaviour of M1, which had been targeted until 1982, has become particularly unstable. With financial innovations allowing households and businesses to economise on transactions balances, its income velocity has tended to accelerate. In 1990, M1 actually contracted (Table 7), as high interest rates induced a shift out of (predominantly non-interest bearing) currency and demand deposits. None the less, despite its unstable velocity, M1 is still considered a useful indicator of real activity. The behaviour of the broader aggregates has been less affected by financial innovation, with the velocity of M2+(6), in particular, tending to decline more or less in line with previous experience. Hence, given its role as a good indicator of nominal spending, the growth of this broad aggregate at double-digit rates in recent years has had some bearing on the stance of monetary policy. Growth of M2+ moderated in 1990, as demand for credit slowed markedly. This reflected the impact of high real interest rates and falling real estate prices, which curbed household spending and led to the postponement of investment projects. Moreover, the financial position of both households and businesses at present is worse than at the outset of the 1981-82 recession, with the household debt/income ratio reaching an all-time high. The growth of monetary aggregates rebounded towards the end of 1990 and, in some cases, into 1991. The recovery of of M1 has been associated in part with a rebuilding of cash balances in response to falling interest rates. Relatively small sales of Canada Savings Bonds boosted the growth of the broader aggregates. The authorities acknowledge that broad money growth needs watching, as a return to growth at double-digit rates would not be consistent with the inflation targets.
[Tabular Data Omitted]
In view of stubbornly high inflation expectations, as evidenced by wage settlements and long-term interest rates, and the risk that the temporary rise in oil prices and the introduction of the GST might lead to a wage-price spiral, monetary authorities have permitted monetary conditions to ease only gradually in response to the weakening of economic activity. By actively resisting too rapid an interest-rate decline, they have avoided a repeat of the January 1990 episode, when a decline in policy-influenced short-term interest rates was interpreted as a change in monetary policy and resulted in strong downward pressure on the Canadian dollar. Consequently, the differential between Canadian and U.S. rates, though narrowing, has remained substantial. Still, by late June 1991, the interest rate on three-month commercial paper had dropped by more than 5 percentage points from a peak of 14 per cent in May 1990. Administered rates, such as the prime business lending rate and mortgage loan rates have broadly followed market rates. Long-term government bond yields averaged nearly 11 per cent in 1990, considerably exceeding those in the United States, despite a lower inflation rate in Canada (Diagram 12). With the differential between Canadian and U.S. rates narrowing somewhat, bond yields have been fluctuating at around 10 per cent since the beginning of 1991. As long-term rates have eased much less than short-term rates, the negative yield gap, which had opened in late 1988 and amounted to as much as 3 percentage points from mid-1989 to mid-1990, disappeared in March 1991, and more recently the yield curve has become upward sloping.
While the upward movement of the exchange rate in parallel with interest rates had reinforced the tightening of monetary conditions in the late 1980s, their easing since mid-1990 has been damped by the continued strength of the Canadian dollar (Diagram 12). The narrowing of the differential between Canadian and U.S. short-term interest rates since mid-1990 has left the exchange rate against the U.S. dollar largely unaffected; at just under 2 1/2 percentage points, as measured by three-month commercial paper rates, the differential is still large by historical standards. In effective terms, the the Canadian dollar weakened during the latter part of 1990 but has recovered since in parallel with the appreciating U.S. dollar. Although the authorities have continued to intervene, at times substantially, in foreign exchange markets, they emphasise that they have no explicit target for the exchange rate and that, in principle, an appropriate easing of monetary conditions could have been accomplished by a combination of exchange-rate and interest-rate easing. None the less, while it is true that monetary authorities have only very limited control over how a change in monetary conditions is split between interest-rate and exchange-rate changes, maintaining confidence in the Canadian dollar has played an important role in the implementation of monetary policy, as destabilising speculative movements in the exchange rate could threaten the achievement of price stability.
The Government taking office in 1984 faced a federal budget deficit of 8 1/2 per cent of GDP (public accounts basis) and a debt/GDP ratio of nearly 45 per cent. In the following three years, corrective fiscal measures, combined with strong economic growth, reduced the deficit by more than C$10 billion to under C$30 billion or 5 per cent of GDP, and the primary balance moved into a slight surplus. Since 1987 budget consolidation has lost momentum: although the deficit has continued to fall a little in relation to GDP, it has remained broadly unchanged in absolute terms, despite strong economic growth until 1989. Reflecting continued efforts to curb programme spending, the primary balance has moved further into surplus, but this has simply sufficed to compensate for rising debt charges. With the debt/GDP ratio approaching 55 per cent and more than half of the federal debt rolled over annually, the federal budget was highly vulnerable to the sharp rise in interest rates in the late 1980s. More recently, the adverse effects of the recession on public finances have frustrated deficit-reduction efforts.
Budget restraint measures taken in 1989 in the face of higher-than-expected interest rates were discussed in last year's Survey. The February 1990 Budget was introduced against the backdrop of slowing economic growth. Budget projections were based on the assumption of a decline in interest rates from their high 1989 levels and a rebound in economic growth from the second half of 1990. In the fiscal year starting in April 1990, the federal deficit was projected to fall to C$28.5 billion (4.2 per cent of GDP). This was to be achieved through budget savings amounting to just under 1/2 per cent of GDP to offset higher debt charges and transitional costs(7) of the introduction of the GST. Budget measures consisted of a series of expenditure restraint initiatives (the Expenditure Control Plan, for details see last year's Economic Survey). In the event, the deficit appears to have risen to C$30.5 billion (4.5 per cent of GDP), and the debt/GDP ratio exceeded 57 per cent at the end of FY 1990/91. Expenditure grew considerably faster than projected (Table 8), reflecting greater-than-expected spending on both programmes and public-debt charges. The latter were boosted by interest rates 2 percentage points in excess of Budget assumptions. Some of the overshooting in programme expenditure resulted from weaker-than-expected economic activity, which led, in particular, to higher unemployment-insurance payments. Increases in defence spending relating to the Gulf War were offset by reductions in other departmental expenditure. The rate of growth of budgetary revenues was virtually the same as forecast, with buoyant personal income-tax receipts compensating for the adverse effects of the recession on corporate income-tax and indirect-tax collections. The sharp upturn in personal income-tax receipts in relation to GDP is attributable in part to special factors (such as lower personal income-tax refunds following tax changes), but there is a significant component that cannot be explained by historical relationships, suggesting the possibility of structural shifts as a result of the substantial changes to the tax system in recent years.
[Tabular Data Omitted]
The full impact of the recession on public finances is becoming evident only this year. With the aim of partially offsetting the effects of weak economic activity on tax bases and social-security payments, and in view of additional costs arising from agricultural assistance and the Gulf War, measures were introduced in the February 1991 Budget to reduce programme spending, to increase excise levies, and to raise unemployment-insurance premiums. These actions total C$4.5 billion (2/3 per cent of GDP) and are expected to keep the federal deficit in FY 1991/92 stable at C$30.5 billion, which is C$3.7 billion higher than projected in the February 1990 Budget. Despite additional curbs on expenditure, including a 3 per cent cap on Public-Service wage increases, programme spending is projected to grow by 7 per cent, and to exceed the February 1990 projection by 1 percentage point in relation to GDP (Table 8). More than half of the growth in programme spending is accounted for by increases in unemployment-insurance payments, agricultural support and defence spending related to the Gulf War. Programme expenditure is forecast to rise faster than budgetary revenues. However, with the rise in public-debt charges expected to slow appreciably due to lower interest rates, the rate of growth of total expenditure is projected to fall below that of revenues. The public debt/GDP ratio is expected to approach 60 per cent in FY 1991/92.
Major fiscal actions introduced in the February 1991 Budget, which affect the medium-term outlook for public finances, include the extension of the Expenditure Control Plan to the mid-1990s, legislated ceilings on spending, and the Establishment of a Debt Servicing and Reduction Fund (DSRF). Over the five years of the fiscal plan, cumulative saving from the Expenditure Control Plan measures, along with associated saving in public-debt charges, total almost C$15 billion. In addition to the controls that have been put on about 40 per cent of programme spending, the Government intends to ensure
PHOTO : Diagram 12. INTEREST RATE DEVELOPMENTS through legislated spending limits that total operating expenditure over the next five years does not exceed the planning numbers of the 1991 Budget; this would keep the growth rate of programme spending to an average 3 per cent per year from FY 1992/93 onwards (as compared with average annual growth of 4 per cent since 1984/85). The legislated DSRF will apply GST revenues (as well as net privatisation proceeds and voluntary contributions) to service and reduce the debt; the Government intends thereby to demonstrate its resolve not to finance additional programme spending from increased GST revenues. On the basis of these initiatives, and under the assumption of real GDP growth of 4 per cent per year from 1993 and a continued decline in interest rates, the authorities project the federal budget deficit to fall markedly over the next few years, gradually approaching the fiscal track set out in the 1989 and 1990 Budgets. The objective of a deficit of around 1 per cent of GDP by the mid-1990s would be reached, however, with a higher revenue/ GDP ratio than projected previously. At 53 per cent, the debt/GDP ratio would also be significantly higher than laid out in previous Budgets, despite a projected steady decline from FY 1992/93 (8).
The macroeconomic effects of fiscal action at the federal-government level can be offset by budgetary developments at other levels of government. In terms of expenditure, the provincial, local and hospitals (PLH) sector is larger than the federal government. Because of constraints on access to capital markets and related concerns over bond ratings, the PLH financial deficit has generally remained relatively limited, however, and the Canada and Quebec Pension Plans have consistently recorded surpluses, so that movements in the general-government deficit have been dominated by swings in the federal-government balance (Diagram 13). While the gap between the federal expenditure and revenue-to-GDP ratios narrowed significantly from 1984 to 1990, both PLH expenditure and revenues expanded broadly in line with nominal GDP in that period. This has not excluded, however, short-term swings in the PLH financial balance, which is dominated by developments in the provincial sector. After moving temporarily into financial surplus in 1988, the PLH sector has accounted for nearly half of the rise in the general-government deficit since then (Table 9). The sector's deteriorating fiscal position reflects in part cuts in federal transfers in the context of the Expenditure Control Plan. The Plan and its extension will result in a cumulative revenue loss for provinces of about C$7 1/2 billion in the 1990-95 period. Many provinces can be expected to react to the cutback of federal transfers through retrenchment. Indeed, seven provincial governments have already introduced wage restraint measures. However, some major provinces are less indebted or exposed to the risk that large deficits could result in a downgrading of their bond rating, and the largest province, Ontario, has embarked on a deficit-spending policy to alleviate the effects of the recession (9). As a result, the PLH sector's financial deficit is likely to exceed 1 per cent of GDP this year and may show only a limited decline in 1992.
[Tabular Data Omitted]
The behaviour of budget balances reflects changes both in fiscal policy and a cyclical conditions. The discretionary fiscal effort can be measured by the change in the cyclically-adjusted general-government primary balance (i.e. excluding debt service). According to this indicator (Diagram 14), fiscal policy imparted considerable demand stimulus during the 1982 recession and the first three years of the recovery; this period was followed by three years of substantial, though diminishing, restraint before policy became if anything slightly expansionary in 1989, largely reflecting developments at the provincial level. However, taking into account interest payments, which have macroeconomic effects like other forms of public transfers, the federal budget's fiscal impact was at best neutral at a time when inflation pressures were mounting. Despite continued relaxation at the non-federal levels, the overall fiscal stance again moved towards restriction in 1990. Measures introduced in the 1991 Budget are expected to compensate for higher-than-expected interest rates and to partially offset the adverse effects of the recession on government finances. According to the medium-term fiscal plan, fiscal tightening would lessen, however, from 1993, when strong economic growth is projected to make for a marked reduction in the budget deficit. Action to partially offset the operation of automatic stabilisers - and in particular the move towards balancing the unemployment-insurance account - during a period of economic weakness is required in order to enhance the credibility of the announced medium-term strategy, given the difficulties the authorities have encountered in bringing the deficit down in recent years and the high and rising debt/GDP ratio. If realised, such a fiscal-policy stance will correct the imbalance in the policy mix and thereby facilitate an easing of monetary conditions.
Indicators of sustainability(10) show that the "primary gap" (defined as the difference between the debt-stabilising and actual general-government primary balance), which had been narrowing over the 1985-88 period, has widened since, due to both the drop in real output growth relative to real interest rates and the accelerating rise in the debt/GDP ratio (Diagram 14). The importance of the level of the ratio to the attainment of a sustainable budgetary situation is illustrated by the fact that the prospective narrowing of the negative growth/interest-rate differential is probably not sufficient to prevent a further rise in the ratio in the near term, despite discretionary action to boost the increase in the primary surplus. Model simulations suggest that gains made by offsetting the effects of automatic stabilisers are limited, because such a policy, while leading to a large reduction in interest rates (which lowers debt charges), results in near-term output losses, which tends to raise the debt/GDP ratio. Of course, such simulations cannot capture the possible favourable private-sector confidence effects resulting from the authorities' adherence to medium-term budgetary targets. In any case, increased fiscal consolidation has the advantage of resulting in easier monetary conditions for a given monetary-policy stance. Model simulations provide evidence that expenditure restraint lowers real interest rates substantially over the medium term, thereby encouraging investment, increasing potential output and creating employment.
Structural policies and the medium-term outlook
Despite the broad structural-policy measures implemented in factor and product markets in the second half of the 1980s, there remains unfinished business. As in many OECD countries, agricultural support is at a relatively high level as evidenced by producer subsidy equivalents of 39 per cent in 1990 (United States 30 per cent, EC 47 per cent). Significant inter-provincial trade barriers persist, reducing economic efficiency and welfare: according to some estimates, their removal could save the average Canadian family as much as C$1 000 per year (11). Possible distortions stemming from regionally differentiated unemployment-insurance benefits tend to impede labour mobility and push up the average rate of unemployment. The small remaining barriers between financial institutions adversely affect competition and efficiency in this sector. Recent structural-policy action has tackled financial-market reform, but the other problems mentioned have yet to be fundamentally addressed.
Recent structural-policy developments
Major initiatives on the structural front were the topic of the special chapters of previous Surveys: the Free Trade Agreement (FTA) with the United States was examined in depth in 1989; tax reform, whose second stage - the introduction of the GST - became effective in January 1991, was discussed in some detail in 1990. Part III of this Survey, which deals with labour-market issues, describes and assesses the Government's new Labour Force Development Strategy and the reform of the unemployment-insurance system. This section of the Survey, therefore, only reviews recent developments in other areas of structural policy.
A comprehensive review of agricultural policy was initiated in 1989 by the federal government in co-operation with the provinces, producers and processors. As a result, an income safety net for farmers was designed to replace assistance provided under the Western Grain Stabilisation Act, Agriculture Stabilisation Act and the Crop Insurance Act. The related legislation will be enacted in 1991. The safety net consists of an insurance (Gross Revenue Insurance Programme) and a stabilisation account (Net Income Stabilisation Account), both financed through joint contributions from farmers and the federal and provincial governments. Insured revenue is based on reference prices combined with yields which provide a more comprehensive measure of loss than do prices of yields taken separately. Premium rates are set uniformly for all crops, a feature which should promote neutrality of the programme between crops. As to the stabilisation account, withdrawals by farmers will be triggered when their income falls below a certain level. Some of the aspects of the new programmes are an improvement on the previous system. In the short run, support levels could remain similar to those in previous years, but they should decline subsequently, all the more so if international export-subsidy competition is reduced. Further reforms, in areas such as dairy farming, need to be designed and implemented in order to significantly reduce assistance and enhance responsiveness to market forces.
In the area of energy policy and resources, the federal Canadian Exploration Incentives Programme, which provided financial incentives for mineral, oil and gas exploration and benefited in particular small enterprises, was cancelled by the 1990 Budget, with temporary arrangements continuing until 1991. Provincial support will persist, however, under Alberta's Royalty tax credit programme. While federal support was withdrawn from the construction and operating phases of the proposed OSLO synthetic oil project, the Government confirmed its support for the Hibernia offshore "mega project" and will provide a direct contribution of C$1 billion (one-fifth of the total cost), a C$1.7 billion federal loan guarantee and other assistance.
The Government has undertaken a number of additional initiatives intended to further improve efficiency, control spending a raise revenue on government operations. One such initiative has been the rationalisation of railway services designed to allow a reduction of subsidies. Increased competition following the comprehensive regulatory reform of the transportation sector appears to have benefited consumers, but in combination with the down-turn in the economy, it has resulted in heavy financial pressures on all carriers. Reforms in the telecommunication sector have been primarily motivated by the need to compete with producers in the United States. Recent developments include the introduction of new telecommunication services, the replacement of a (regulated) monopoly by a (regulated) duopoly in the supply of cellular phone services, and a substantial decline in long-distance rates. No decision has been reached, however, on such questions as the desirability of opening public long-distance telecommunications to new providers. A new legislation regulating the sector is ready to be introduced, notwithstanding some provincial sensitivities to future power-sharing with the federal government in a broader context.
The Government has undertaken a full examination of legislation governing the financial sector in order to update and modernise the rules and regulations pertaining to federal financial institutions. To this effect, new legislation (the Trust and Loans Companies Act Bill, Bank Act Bill and Insurance Companies Act Bill) has already been submitted to Parliament. Another Bill covering insurance companies and co-operative credit associations is to be introduced in the fall of 1991. Responsibility for regulating the banking system is with the federal government, but trust and loan and insurance companies may choose to be regulated federally or provincially. The reforms will continue the process of dismantling remaining barriers between banking, insurance and trust and loans institutions and thus allow financial institutions to offer a wider range of services to customers. The reforms will apply to domestic and foreign-owned firms alike. The proposed legislation will also provide the basis for discussions with provincial governments on the harmonisation of regulations and supervisory systems.
So far, twenty public enterprises (Crown corporations and other government holdings) have been divested, and nine others have been dissolved. In the 1990 Budget, the Government announced its intention to begin action in the privatisation of Petro-Canada, to divest its shares in Telesat Canada and to proceed with the sale of two other Crown corporations. The privatisation of Petro-Canada has been approved by Parliament; the operation will be done in phases. Legislation enabling the Government to proceed with the sale of its shares in Telesat Canada is expected to be introduced this year. In the 1991 Budget, the Government reaffirmed that privatisation remains a priority and that future net proceeds would go to a fund which will be used for deficit reduction. It also announced its intention to sell Canada National Exploration, the oil and gas operations of the Canadian National Railway Company.
In the area of trade policy, implementation of the FTA with the United States has proceeded as planned. Tariff reductions have even been accelerated under the pressure of the private sector, which has been interested in lower import costs or improved export opportunities. Accelerated tariff reductions, which became effective in April 1990, affected two-way trade of a total value of C$6 billion comprising a wide range of products; a new round of advanced tariff reductions is expected to be implemented by July 1991. Discussions with the United States and Mexico have taken place with a view to creating a North-American free-trade area, which would represent a common market with a population of 360 million people. The three countries initiated negotiations on a trilateral FTA, which would progressively eliminate barriers to flows of goods and services and investment and establish a dispute-settlement mechanism.
The Government demonstrated its commitment to environmental action with the announcement of the "Green Plan" in December 1990, providing for additional public spending of C$3 billion. In view of the deteriorating fiscal situation, the 1991 Budget, while preserving the total funds for the Plan, extended the time period for its implementation from five to six years. The main areas covered by the Plan are the following: addressing pollution-related problems by protecting water and air quality, eliminating persistent toxic discharges and cutting the generation of wastes by 50 per cent by the year 2000; sustaining Canada's renewable resources; protecting unique ecological areas and sustaining wildlife; protecting the Arctic environment; stabilising emissions of greenhouse gases at the 1990 level by the year 2000; providing better information on environmental matters, strengthening enforcement of regulations, improving emergency preparedness, and supporting relevant science and technology. Specific proposals and legislation are being prepared and some are already being implemented.
The medium-term outlook
The structural initiatives taken over the last few years - in particular the FTA with the United States and the reforms of income and sales taxation and of the unemployment-insurance system - will improve supply-side conditions and raise the the level of potential output, though it is difficult to quantify their positive impact on economic efficiency and the supply of capital and labour with precision. Officials estimates, which are broadly supported by work of independent research institutions, suggest that the largest gains will be associated with the FTA: once the agreement is fully implemented and the economy has adapted to it, output may be 3 1/2 per cent higher than it would otherwise have been. The sales-tax reform may have adverse transitional effects, as personal consumption makes way for higher capital formation, but could raise output by nearly 1 1/2 per cent in the long run. Additional potential output gains are expected to result from income-tax measures and recent labour-market reforms. The latter are estimated to lower the "natural rate" of unemployment by 1/2 percentage point (see Part III below). These effects are large; but given the poor supply-side performance in the 1980s, such improvements are essential if official medium-term projections are to be realised.
Latest official medium-term projections (Table 10) are for strong growth in output and employment combined with a marked fall in inflation; under this scenario, by 1996 inflation would be reduced to a rate last achieved in the early 1960s and both the public-sector and external deficits would have turned into surpluses. The following assumptions underlie these projections:
- Potential output growth picking up from below 3 per cent per annum
at present to 3 1/4 per cent from 1993 to 1996, in line with most other
- A gradual, but not complete, closing of the current 6 per cent gap
between actual and potential output over the period 1992 to 1996;
- A modest decline in real interest rates, which nevertheless remain
Table : Table 10. Medium-term projections
Annual percentage change
1990 Budget 1991 Budget 1992-95 1992 1993-96 Real GDP 3.5 3.5 4.0 Real exports .. 5.2 4.4 Real imports .. 3.1 4.0 Employment 2.2 2.1 2.7 Unemployment rate(1) 7.6 9.8 8.6 Unit labour costs .. 1.7 1.4 Inflation (CPI) 3.0 3.0 2.2 External balance (C$ billion) .. -6.6 0.4
Short-term interest rates(1)
Nominal 7.2 9.0 7.0 Real 4.2 5.8 4.7
(1.) Per cent. Source: Ministry of Finance. The projected increase in potential output growth is partly the result of structural reforms which are estimated to add 1/2 percentage point per annum to potential output growth over the projection period. A considerable margin of error is, however, attached to estimates of potential output. Thus, it cannot be excluded that the output gap closes earlier than officially expected which could jeopardise the envisaged inflation performance. Another notable feature of the projections is the stability of the import/GDP ratio, in contrast to its rapid rise during the 1980s; this result is based on the projected low domestic demand pressure, the absence of a rapid real appreciation such as in the 1980s, and removal of the import bias which was associated with the abolished federal sales tax.
In the 1991 Budget, the authorities recognise that, notwithstanding significant progress in structural reform, more needs to be done to improve conditions for sustainable growth. Apart from a stable macroeconomic environment, better productivity performance requires further microeconomic policy measures which improve the quality and efficiency of inputs (both physical infrastructures and human resources). The authorities are aware of the fact that investment in infrastructures and R & D efforts may have been inadequate over the last decade and intend to play a role in this area, in cooperation with provincial governments and the private sector. The experience of the 1980s has also shown that a skilled and well-trained labour force is crucial to facilitate adjustment to changing production structures and improve economic performance. The need for renewed efforts in the area of training and education and recent initiatives to promote labour-market adjustment are the subject of the following Part of the Survey.
PHOTO : Diagram 13. GENERAL GOVERNMENT REVENUE AND EXPENDITURE
PHOTO : Diagram 14. INDICATORS OF FISCAL POLICY(1) (1.) National accounts basis. OECD projections.
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|Publication:||OECD Economic Surveys - Canada|
|Date:||Aug 1, 1991|
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