The Canadian economy has performed remarkably well for the past decade and a half. Real GDP growth has been robust, employment gains have been impressive, the unemployment rate has fallen to its lowest level in a generation, and positive terms-of-trade effects have combined with real per capita output growth to boost Canadian living standards. Furthermore, higher commodity prices have led to a rapid appreciation in the dollar back to around parity with its US counterpart, helping to discipline wage- and price-setting and meet the official inflation target. Domestic price inflation has also been held in check by expanding production capacity, thanks to rising female and older-worker labour-force participation, which has more than compensated for relatively weak productivity growth. However, high commodity prices and the resulting currency appreciation have been forcing rapid economic adjustments through industrial and regional employment shifts. Most signs point to orderly adjustment – even resource-poor regions have seen overall employment gains, despite substantial losses in manufacturing.

A long period of record high growth in Canada appears to have now ended with the global financial market dislocation and cyclical slowdown. A positive terms-of-trade shock (well over $100 oil and exchange-rate parity with the US dollar) has meanwhile boosted incomes and energy-sector prospects but also dragged down export values, especially in manufacturing. A key macroeconomic policy challenge will be to balance upside risks to inflation in the medium term and downside risks to growth in the short run, while ensuring that symptoms of Dutch disease do not develop. Realising Canada’s full potential in the face of imminent demographic ageing requires later retirements and overcoming a persisting productivity gap vis-à-vis the United States via structural policies. Looking further into the future, Canadian and world welfare will depend on curtailing present levels of greenhouse gas emissions. The highly emitting energy sector, in particular, is not sustainable on current development patterns. Outdated policies in the agricultural sector also distort Canada’s natural comparative advantage in food while denying domestic market access for poorer food-producing nations. Given its many advantages, there is no reason Canada cannot successfully deal with the challenges posed by new terms of trade, ageing and climate change.

Macroeconomic policies for the end of a boom cycleCanada’s economy has greatly benefited from the commodity boom of the past few years, though the resulting exchange-rate appreciation has put strains on the central regions that have a more balanced economic base. But the economy has proven flexible and has entered the current phase of global economic turmoil from an enviable position. Despite an expected slowdown in 2008, the economy is expected to rebound in 2009 and emerge from the credit crisis relatively unscathed. The baseline projection calls for growth well above recession territory – even if below potential rates – for both 2008 and 2009. Looking further ahead, there are significant risks to the Canadian economy from worldwide adjustments to the large global current account imbalances that have been building for some time, particularly in the United States. Nevertheless, weathering short- and medium-term macroeconomic tempests should not detract policymakers from longer-term structural issues identified in past Surveys. Recent experience in credit markets harbours lessons that the central bank and financial-market regulators can use to strengthen financial-system efficiency, stability and transparency. And the coming wave of baby-boomer retirements calls for fiscal policymakers to improve expenditure controls, accelerate debt reimbursement and put more of current resource revenues aside to help prepare for the fiscal implications of demographic change.

The Canadian government has set a high priority on reducing the economic burden of taxation. In a context of fiscal surpluses, it has been: markedly reducing corporate income and capital taxes; providing more personal tax relief especially at lower incomes and above all for saving; and cutting the federal value added tax (GST). While such measures, in particular income and capital tax cuts, reduce the economic damage caused by tax and improve business competitiveness, Canada should go further along this route with significant revenue-neutral reforms to achieve a more efficient tax mix that also retains its redistributive features. Numerous tax preferences to favoured activities, firm types, investments and savings vehicles narrow the tax base and create loopholes, keeping statutory rates higher than otherwise and distorting resource allocation. They should therefore be removed. It would also help to shift the tax mix toward more user fees and indirect taxes – including VAT, environmental levies and property taxes – which do not distort inter-temporal economic choices as income taxes do. Lower corporate and personal income taxes could improve the incentives for capital formation, FDI, innovation, entrepreneurship, labour-force participation, work effort, and the pursuit of higher education. The result would be higher standards of living.

Energy represents a major sustainable-development challenge for Canada. In the short term, labour shortages and infrastructure bottlenecks are likely to hinder energy developments and need to be addressed. In addition, provincial fiscal management could be improved by adopting prudent allocation and withdrawal rules of revenues from non-renewable resources to and from a long-term fund. Eventually the main challenge will be to curb greenhouse gas emissions (GHGs), despite the rapid expansion of high emitting sectors. The effectiveness of environmental policies could be enhanced by better federal-provincial coordination. Efforts should be concentrated on designing and implementing an emissions-trading scheme compatible with corresponding systems abroad. Finally, effective and efficient systems of regulation and taxation are essential to facilitate the timely realisation of energy supply plans.

The agricultural sector in Canada is relatively large, compared to those in most other G7 countries. In recent years, the federal and provincial governments have undertaken a number of sectoral reforms to meet the competitiveness and environmental challenges that it faces. The federal government has tried to end a marketing monopoly in the barley market and may do so for wheat as well. The next generation of agriculture and agri-food policy is being finalised, and implementation of the first part of a new framework, Growing Forward, has begun. But a steady stream of ad hoc programmes in recent years has had significant budgetary costs and no doubt created moral hazard among farmers. There is scope for further liberalisation in supply-managed sectors, which are heavily protected and subsidised by consumers. Moreover, Canada’s bio-energy production, in particular the production of second-generation bio-ethanol (from cellulose) is under pressure in light of less costly bio-energy production overseas. Against this background, governments are striving to ensure the long-term viability of the sector.