The Canadian Economy
The Empire Club of Canada Addresses (Toronto, Canada), 13 Oct 1983, p. 51-64
Mulholland, William D., Speaker
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The Canadian economy. Review and analysis of Canada's current and future economy. Problems identified. Monetary and fiscal policies. Budget deficits. Business investments. Recession. Economic recovery. Protectionism. Debt management of third-world countries. Fiscal discipline. Trends in world trade. GATT.
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13 Oct 1983
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OCTOBER 13, 1983
The Canadian Economy
CHAIRMAN The President, Douglas L. Derry, F.C.A.


Distinguished guests, members, and friends of The Empire Club of Canada: The past decade has been one of considerable challenge, opportunity, and accomplishment for Canadian banks. It has been one of rapid international expansion and widely fluctuating domestic needs. Assets and earnings grew rapidly until, at what we all hope to have been the height of our inflationary cycle, the federal government was sufficiently concerned over bank profits that the Standing Committee on Finance, Trade and Economic Affairs was asked to look into these profits - yet, by the time the committee met last year, the recession had struck with such impact that the thrust of the review was not whether bank profits were excessive, but whether the Canadian banking system could withstand the incredible jolt of the loan losses, which were to be more than double those of the previous year. The conclusions of the committee were reassuring but as 1982 progressed, constant media attention on the future of Dome Petroleum, various real estate companies, Massey-Ferguson, and Turbo Resources, as well as sovereign risks such as Poland and Mexico, kept the public wondering what the future might hold for the banks, and indeed, the whole economy.

In the current year, in spite of most bankers praying that the worst was past with 1982, loan losses have continued to increase, reflecting the continuing pressure upon Canadian business. However, lower inflation and the related lower interest rates give increased reason for believing the future to be more promising. Throughout this period, today's speaker has played a key role as a leader and spokesman for the banking fraternity and for his own bank.

Bill Mulholland was born in 1926 in Albany, New York. After graduating with an M.B.A. from the Harvard Business School, he joined the investment banking firm of Morgan, Stanley and Co., in New York in 1952, becoming a partner ten years later. During this time he was responsible for assembling the financial package for the Churchill Falls hydro project in Labrador. In 1969, when key Churchill Falls executives were killed in a tragic plane crash, Mr. Mulholland became President and Chief Executive Officer of Churchill Falls (Labrador) Corporation Limited and of Brinco Limited, in order to finish the job. It was in 1971, while fulfilling this responsibility so ably, that he last addressed The Empire Club. He told a large and appreciative audience of the progress of the Churchill Falls project, and of possible plans for its future. The thing he stressed most strongly was the emphasis that must be placed upon planning, in order for such a mammoth project to be successful. It is this success with Churchill Falls, and his emphasis on proper planning, management processes, and information systems that made Mr. Mulholland so attractive to the Bank of Montreal, which he joined to become President in 1974. In 1979 he was appointed Chief Executive Officer and in 1981 was elected Chairman of the Board of Directors.

Since 1974, the Bank of Montreal has experienced widespread change. There have been major staff realignments, including the hiring of new people at the most senior levels. In the mid-1970s the bank had a rapid transition from a relative lack of computer technology to being in the forefront of Canadian banks in this area. The acquisition of Chicago-based Harris Bancorp, which was announced last week, will have the effect of increasing the Bank of Montreal's assets by some nine billion dollars, bringing them to seventy-two billion dollars, which will make it, in terms of assets, Canada's second largest bank. In the current year the Bank of Montreal has been ranked by Euromoney magazine as thirty-first largest in the world in terms of shareholder funds, and as twenty-fourth largest in terms of net profit. Other than the resource sector, in which Canada has evident advantages, there are few industries in which our country has such a major world-scale impact.

In addition to his responsibilities with the Bank of Montreal, Mr. Mulholland serves on the boards of a number of charitable and policy-related organizations. After spending a number of years commuting between Toronto and Montreal, Mr. Mulholland and his family moved to Toronto earlier this summer.

It gives me great pleasure to welcome Bill Mulholland back to The Empire Club to address us today on "The Canadian Economy."


Mr. President, ladies and gentlemen: Nearly eighty years ago, Sir Wilfrid Laurier confidently asserted that the twentieth century would belong to Canada. Of course, he also expected that, by now, Canada's population would be about sixty million. It has been clear for some time that Canada has not lived up to Sir Wilfrid's high expectations. But, then, neither has the twentieth century.

If Sir Wilfrid were living today, I wonder what he would say about Canada's claim on the twenty-first century. He was a man of vision, so I doubt that he would be entirely comfortable among those whose horizons are limited by the economic valley which we have been traversing for the past couple of years. I suspect that he would recognize that Canada has fundamentally a strong and healthy economy, that Canada is a country well-off in terms of its human capital and natural resources, that the economic base from which Canada will be working during the next few years of adjustment and transition is the envy of peoples the world over. And he would be right.

What is the basis for the view that Canada's economic future, once thought to be so bright, is now so lacking in appeal? It stems, I think, from a critical view being taken of our economic performance in recent years, compounded by a recession-bred pessimism.

Let's take a quick look at the record of the seventies. This was not the best of decades, yet Canada achieved substantial gains. Total Canadian output increased by almost 50 per cent. Employment increased by 35 per cent. Real per capita income after taxes - probably the single best measure of what the economy yields to individual Canadians - rose by 52 per cent. From the perspective of history, such an increase is enormous. If that rate were to continue, our children would have twice our present real income before they reached our age.

Admittedly, the last couple of years have been rough on Canada. Some of the gains won in the seventies have been given up in the eighties. The deep recession left many of our plants idle, and too many Canadians out of work. Real per capita disposable income plummeted, and business profits collapsed. We should not, however, let our vision of Canada's future be shaped by this experience. The devastation wrought by the recession was largely the result of specific policies of western governments - policies whose single-minded objective was to reduce inflation and inflationary expectations. They accomplished their goal, but at the cost of quite a few babies going out with the bathwater. My purpose is not to defend the record of the past but to point out that neither is Canada's economic future clouded by some overriding disability nor is the base from which we go forward nearly as weak as we seem to think it is. By any objective standards, it is pretty solid.

The recovery has now begun strongly, at least in North America. The pace of recovery in the months ahead will doubtless slow from the unsustainable rate posted in the first half of the year. This is to be expected and has been forecast for months. It should be welcomed, rather than feared, since a moderate recovery holds out the greatest promise of a return to an era of economic stability. Only in an environment of low inflation will there be significant growth in business investment and capital accumulation, as well as sustainable economic growth.

There is nothing in the current performance of the economy to suggest that the recovery is about to be derailed. Assertions to the contrary reflect a basic misunderstanding of the effects of the policy forces now in place.

Large budget deficits will be a continuing problem but, despite views to the contrary, they will not, by themselves, abort the recovery. Failure to accomplish significant cuts in our budget deficits means the prospective recovery will be one which favours government consumption at the expense of business investment; it means slower growth in our nation's productive capacity, and hence, our living standards; it means ultimate acceptance of higher rates of unemployment if we are to preserve the gains we have made on the inflation front. It probably also means that our ability to achieve the strongestpossible competitive posture in world trade will be curtailed. It does not mean, however, an end to the recovery itself. That will depend on the posture of monetary policy.

The monetary authorities certainly have the power to engineer an end to the recovery, but the monetary policies in place in North America do not suggest anything of the sort. Indeed, by both word and deed, the monetary authorities are indicating that they are willing to provide the means to finance a moderate recovery - but not a boom. Barring a sharp reversal of current policies, a moderate recovery is still what we are most likely to experience.

Monetary and fiscal policy are indeed important, but they are not the only factors that will determine the strength of recovery. Of equal importance is Canada's trade performance. A third of our national output is tied to exports, and a fifth of GNP to exports to the United States alone. Canada cannot realistically hope to isolate itself from world economic trends - be they in the oil market, the financial markets, or the ever more competitive markets for manufactured goods. Our economic strategy must rest, therefore, first, on strong support for an open world economy and trading system and, second, upon a national commitment to achieve and maintain a strongly competitive trade performance. Canadians must be brought to a realization that their standard of living and that of their children will be determined by their country's success in world competition.

Obviously, my own views reflect the conviction that the case for optimism, while hardly airtight, is nevertheless pretty good. I would like to persuade you that we should now be working to make the case even stronger - not automatically assuming the worst and waiting in the storm cellar for our lugubrious prophecies to be fulfilled.

This will require a realistic understanding of our situation, a measure of consensus, a collective will to act, and most importantly, confidence - confidence in ourselves, that we can, by our own actions, shape our future. Canadians have proven before that when the chips are down, they can deliver. I know, and so do you, that they can do it again. So, why should we view the future with pessimism?

At the moment, the recovery in Canada and the United States has been a good deal stronger than in the rest of the world. It should spread gradually to Europe, Japan, and the developing countries in the course of the next year. But this will only be the first phase of world economic recovery. It will allow the world economy to win back the ground lost in three years of recession. To assure that the recovery is sustained, however, three key conditions must be fulfilled.

First, deficit spending must be controlled while monetary policy is eased in the industrial countries, which will permit real interest rates to decline gradually.

Second, the line must be held on protectionism in major trading countries, which will set the stage for renewed expansion of world trade.

Third, developing countries' debts must be managed in an intelligent, co-ordinated manner, which will stabilize the international financial system and permit the economies of these countries to start growing again.

It is clear that in western countries greater fiscal discipline and a slight easing of monetary policy would permit a decline in interest rates. Not so widely appreciated, however, is the danger of protectionism. Increased protectionism would impede a lasting recovery just as surely as a rapid rise in interest rates.

World trade declined last year and remains below its 1980 level. It shows every sign of stagnating this year. We are experiencing a three-year period of stagnation in international trade that is unprecedented in the postwar era. Major industrial nations have made commitments on several occasions to hold the line on protectionism - and, if possible, to roll it back. They must make every effort to live up to their commitments despite the pressures created by unemployment, which is expected to remain high in most countries. Both renewed expansion of world trade and interest rate stability in the industrial countries would greatly assist the world in meeting a third requirement for lasting recovery. I refer to the sound management of debt payments by numerous developing countries. Already, the decline in interest rates from last year has reduced their debt service charges - in point of fact, each percentage point reduction in interest rates cuts the debt burden of developing countries by about two billion United States dollars a year.

The recovery in industrial countries will boost demand for developing countries' exports and in turn help them to generate more foreign exchange to service their debt. Also of help has been closer co-operation among the International Monetary Fund, other international institutions, hundreds of commercial banks, and national governments. Further progress is needed, including perhaps the creation of new financing instruments and new institutional approaches. Still, international co-operation is far better today than it was a year ago.

Over the longer haul the developing countries will be able to service their debt smoothly only if they receive increased flows of official aid and foreign direct investment. Most importantly, developing countries will need free access to export markets in the industrial countries - not only to generate the foreign exchange necessary to service debt but also to fuel economic growth.

Trends in all three of these areas - interest rates, world trade, and international debt - will have a direct impact on the strength of world economic recovery. The points which I have mentioned will probably not be followed as faithfully as one might wish. But countries that adjust quickly to economic reality will tend to benefit from relatively stable currencies, relatively low real interest rates, and relatively strong growth in output and living standards.

The implications for Canada are clear. This country, along with the United States, has allowed its deficit to expand rapidly while most other industrial countries were practising fiscal restraint. We must control deficit spending. Canada is also more dependent on trade than many countries. We must meet increased competition in world and domestic markets.

To improve our competitive strength, we will have to shore up numerous fault lines in the structure of our economy - inflexible wage and cost structures, burdensome government regulations, and regional barriers to the movement of labour, capital, and technology. Business and government will also have to work to develop new policies and programs to encourage research and development - R and D - and to improve the education and training of our most precious resource - people. In short, we will have to become more flexible and adaptable to change. For therein lies the key to an improvement in our competitive strengths as an experienced, respected trading nation.

These are major challenges. But I cannot emphasize too strongly my belief that we have the fundamental strengths to meet them.

One recent development has been particularly encouraging. I refer to the remarkable decline in inflation, from almost 13 per cent to less than 6 per cent. Wage settlements have declined in line with prices, easing the wage/price spiral that proved so intractable in the 1970s. This is a major source of strength as we attack our deeper-rooted economic problems.

One of these problems is the current weakness of business investment. During the recession, it fell much more sharply, by 20 per cent, than in past downturns. It will decline further this year. The traditional role of investment in sustaining recovery, once the current growth in consumer spending levels off, remains in some doubt. There are several reasons: substantial excess capacity; weak corporate balance sheets; and the fact that corporate profits, relative to output (GNP), last year hit their lowest level since the Great Depression. The combination of declining sales and high interest rates during the recession was the key factor contributing to the weakened financipl condition of businesses. This will take some time to correct, but the process is under way.

In all likelihood, confidence is another important, if elusive, factor in determining the climate for capital investment. Many businessmen have been badly burned by recent events and are going to be doubly cautious - and understandably so - about taking on substantial financial commitments. To a degree this is healthy, but not if it is overdone. We are going to need a resumption of capital spending if the economy is to heal itself and move on to a more comfortable and sustainable track. Indeed, my perception is that business, for its own sake, will need to invest in order to protect and to enhance its competitive position. Productivity is not just working harder or working for less money, it is "working smarter," more efficiently, more innovatively - and for this it takes investment in plant, in machinery, and in people. We may have to scratch a bit, but I am convinced that this is the right thing to do and now is the right time to do it.

In the future, another important inhibitor to rapid growth in business investment is likely to be persistent deficit spending. My concern, I should emphasize, is not last year's deficit or even this year's. Indeed, they helped cushion the economy from the worst effects of the recession. And the recovery will itself shrink the federal deficit because tax revenues will be increased and unemployment insurance and other expenditures will be reduced. What worries many observers, myself included, is the "built-in" or structural deficit, in other words, that portion of the deficit that does not disappear when recovery ensues. It is important that structural deficits fall quickly enough to make room for expanding credit demand from the private sector.

Of course, it is not realistic, politically or economically, to expect the federal government to slash its structural deficit radically overnight. This would require either massive tax increases or major cuts in spending and government programs. Such measures would not be accepted by the Canadian public and they could endanger recovery. Once the recovery is more advanced, however, Canadians will have to seriously consider spending cuts or tax increases, or both.

Moderate tax increases can contribute to keeping our deficits under control. But it seems clear that the most effective method, if not always the most popular, is for the federal government to continue to impose strict controls on growth in spending. Government spending should fall, but only in relation to an expanding GNP, not in absolute terms. We need not contemplate an across-the-board retreat by government. Nevertheless, Canadians must face one hard fact: spending restrictions will in all likelihood reduce the level of government service, even if tax dollars are spent with the wisdom of Solomon.

It may be hard for the public to accept, and for politicians to admit, that government can no longer afford to intervene at will. As matters stand, however, governments must make spending commitments only in priority sectors, where the benefits clearly justify the costs. A strong national consensus on the spending priorities must be reached soon if the government is to hold the line on deficit spending.

If recovery is to be strong, Canada's government must also hold the line in another area - protectionism.

Protectionism threatens Canada as much as it does the developing countries. It threatens to reverse long-term trends that are running in our favour. In the past twenty years, Canadian industry has greatly expanded exports, while adjusting with relative ease to increased import competition. This was made possible by progressive declines in tariff barriers and virtually uninterrupted growth in world trade.

The extent of Canada's dependence on trade is not, perhaps, widely enough appreciated, even by Canadians. Neither is our strength as an exporter. Trade underpins not only our agricultural and natural resource sectors but many manufacturing industries as well. A third of our manufacturing output is exported. More than half the production of seven major manufacturing industries is exported. Among them are aircraft, automobiles, machinery, and electronics. Some of the strongest export performers are high-tech producers of telecommunications, electrical generating and urban transportation equipment. Over the years, increasing numbers of our manufacturers have come to depend on lower - not higher - tariffs and easier access to export markets, particularly south of the border.

It is clearly in our long-term interests, not to mention our short-term interests, to resist protectionism. This means, first and foremost, supporting the multilateral free trade rules of the General Agreement on Tariffs and Trade, or GATT.

This is not to deny the importance of our bilateral relationship with the United States. Indeed, this relationship could spawn new trade arrangements in specific sectors. But we must also remember that Canada depends to a much greater extent on the markets of its major trading partners - the United States, the EEC, and Japan - than it does on our relatively small domestic market. That makes it tougher for us to win concessions in bilateral trade dealings. Our bargaining power is significantly greater within the framework of GATT, which groups eighty-eight countries and is designed to prevent discrimination against any single country, large or small, by another. It is in Canada's interest to support extension of GATT to agricultural products and trade in services.

To benefit from GATT, however, Canada must continue to adhere to a progressive reduction in tariffs on imports and agree not to replace tariff walls with an array of new, non-tariff administrative and quota barriers. Otherwise, "Buy Canada" laws will begat "Buy America" laws, and vice versa, until they combine to infest the North American economy.

So far, I have outlined two key requirements for sustaining Canada's recovery through the mid-1980s. They are deficit control on the one hand, and expanding world trade and a halt to protectionism on the other. Both provide challenges to which the Canadian economy will have to respond by becoming more competitive. A number of steps will have to be taken. Productivity growth, which was flat in the 1970s, will have to be restored. Provinces will have to consider lowering regional barriers to the free flow of capital and labour. All levels of government will have to lighten the burden of inefficient, costly regulation.

In many cases, change will come slowly. But one area that will soon require attention is the possibility of inflationary increases in wage costs. This raises the issue of wage and price controls. It seems to me that the federal government's 6 and 5 program was successful and well-timed. Public salaries were controlled at a time when the recession had abruptly halted private sector wage increases; but the necessity for wage restraint will be called into question as the economy expands and corporate profits rebound.

In the course of the recovery, labour will no doubt step up demands for wage increases. To the extent that these demands are tied to productivity growth in specific industries, they should be regarded as legitimate. The danger is that pattern bargaining would spread increases that are justified in one industry on to others that may not be so productive. If this happens, wage increases will again fuel inflation and undermine the competitive position of industries that are recovering relatively slowly from the recession. Under no circumstances should wage settlements in the public sector be permitted to set the pace for wage increases generally.

Before the 6 and 5 program expires next summer, the federal government, in consultation with business and labour, might consider implementing a more flexible policy, designed to last. The emphasis should be on maintaining a degree of restraint while providing incentives to efficient producers. The aim should be to give Canadian corporations a more flexible wage structure, one based on productivity and one that would adjust smoothly - rather than under the duress of mass lay-offs - to the ups and downs in specific industries and markets. Such a program should be part of a national effort to increase the overall efficiency of resource allocation in Canada. I don't think I should pretend to you that I have in mind either a comprehensive plan for economic growth in Canada or a clear vision of how the world will unfold over the next few years. Both are well beyond my capacities. I do believe, however, that it is possible to arrive at a realistic assessment of our position - our national balance sheet so to speak - and that the balance is encouraging. I also believe that it is possible to strike an agenda designed to capitalize on our advantages and ensure a continuation of economic progress and material well-being. Finally, I suggest to you that there is far more reason than not to approach our task with confidence.

During this decade, the Canadian economy must be managed with restraint, foresight, and courage and Canada's position in world-wide competition must be pressed with boldness and determination. As a nation, we must recognize - and accept - these challenges. It is well within our abilities to do so, successfully.

Sir Wilfrid, are you listening?

The appreciation of the audience was expressed by Michael Meighen, a Director of The Empire Club of Canada.

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The Canadian Economy

The Canadian economy. Review and analysis of Canada's current and future economy. Problems identified. Monetary and fiscal policies. Budget deficits. Business investments. Recession. Economic recovery. Protectionism. Debt management of third-world countries. Fiscal discipline. Trends in world trade. GATT.