In this article, David Parkinson points out that while Canada’s GDP growth number continues to beat projections, the lack of business investment remains a major weakness. This lesson plan seeks to understand why businesses are unwilling to increase their investments in the Canadian economy and the potential effects of this.
Appropriate Subject Area(s):
Key Questions to Explore:
- What is GDP? Why is it important to economists, government officials and investors?
- What factors are behind the strong GDP numbers we have seen in recent months?
- What is the major weakness in the Canadian economy?
- Why is there a continued lack of business investment in Canada?
- What impacts does insufficient business investment have on the Canadian economy?
GDP, business investment, lagging and leading indicators.
- GDP: Gross domestic product (GDP) is one of the primary measures used by decision-makers, financial and other institutions to evaluate the health of the economy. An increase in real GDP is interpreted as a sign that the economy is doing well, while a decrease indicates that the economy is not working at its full capacity. Put simply, GDP is a broad measurement of a nation’s overall economic activity. Changes in GDP are lagging indicators because they measure historical performance.
- Business gross fixed capital formation refers to additions of capital stock, such as equipment, tools, transportation assets and electricity. Countries need capital goods to replace the current assets that are used to produce goods and services, and if a country cannot replace capital goods, production declines. Generally, the higher the capital formation of an economy, the faster an economy can grow its aggregate income.
- Leading indicator: a leading indicator signals changes in the business cycle (notably, the approach of turning points that see the economy move into recession or recovery) and periods of faster or slower economic growth.
- Lagging indicator: a lagging indicator is a measurable economic factor that is assessed only after the economy has begun to follow a particular pattern or trend.
A copy of article
Introduction to lesson and task:
To fully understand why the lack of business investment in the Canadian economy is a major weakness, it is important to understand how GDP is calculated and what it signifies.
GDP = C+G+I+X
An expenditure based calculation of Canada’s gross domestic product (GDP) is simply the sum of total consumption (C), investment (I), Government spending (G) and net export (i.e. export minus imports, or X in the above equation). The total value of this sum gives us a broad understanding of how well the economy is performing in comparison to prior quarters or years.
In the fourth quarter of 2016, real GDP grew at an annualized rate of 2.6%, beating the consensus estimate among economists of 2%. This growth rate was largely due to strong consumption (C), solid exports (X), and a brisk pace of residential construction and renovation (I).
Over the past four quarters, Canada’s GDP has risen 1.9% year over year. This positive growth number has increased calls for the Bank of Canada to increase interest rates from an overnight rate of 0.5%. However, the Bank has been reluctant to do so due to a continued lack of business investment in the Canadian economy.
In the fourth quarter of 2016, business gross fixed capital formation slumped on an annualized basis by 8.2% and a StatsCan survey of business spending indicates that private-sector businesses plan to reduce their spending by 1.6% in 2017. This is a worrying sign for the Bank of Canada for two reasons: first, investment (I) has a positive and direct relationship with GDP, which measures economic activity. Therefore, a decrease in business investments will lead to a decrease in GDP, as shown in the formula. Second, a reduction in business investments will starve the economy of the tools and productive capacity necessary to increase future growth.
By holding interest rate at 0.5%, the Bank of Canada is incentivizing businesses in the private sector to increase investment in the Canadian economy.
Action (lesson plan and task):
- Ask your students to explain how Canada’s gross domestic product is calculated and state what the growth numbers signify.
- Ask your students to explain why Canada’s gross domestic product is an important indicator to economists, government officials, and investors.
- Ask your students to state some of the limitations of gross domestic product, as an economic indicator. (hint: GDP fails to take the following economic activities into account: non-market production, the underground economy, improvement in quality and immeasurable economic costs like pollution).
- Ask your students to state the driving force behind the growth in Canada’s GDP in the fourth quarter of 2016.
- Ask your students to explain why a lack of business investment in the Canadian economy is a major weakness.
- Ask your students to state some incentives the government could put in place to encourage businesses to invest in Canada (hint: reducing taxes on non-residential investments, prioritizing growth-friendly taxation in infrastructure and electric power, increasing the rewards for R&D and innovation.)
- Ask your students to explain why the Bank of Canada is unwilling to increase Canada’s interest rates, given the better GDP numbers we have seen in recent quarters. (hint: uncertainty due to potential new protectionist U.S. trade policies).
- Ask your students to explain how uncertainty with respect to President Trump’s desire to renegotiate trade deals could further discourage businesses from investing in Canada.
Consolidation of Learning:
- In this article, Mr. Porter, BMO’s chief economist, points out that the Canadian real GDP growth has risen on par with the United States’ real GDP growth. However, the Bank of Canada has held overnight interest rates constant at 0.5% for 12 straight quarters, while the U.S. Federal Reserve has raised the funds rate three times in the past seven quarters from 0.25% in December, 2015, to 1% in March, 2017.
- Ask your students to research the divergence in both economies and explain why the respective central banks have chosen different courses of action.
- After completing this lesson plan students should have a better understanding of how GDP is calculated.
- After completing this lesson plan, your students should also understand the factors that led to better GDP numbers in 2016.
- Finally, students should understand why the continued lack of business investment in the Canadian economy is a source of concern.
- Ask your students to explain the key factors that led to an increase in demand for Canadian goods and services (hint: a depreciated loonie).