Poloz: selling life in the slow lane

It’s in business leaders’ DNA to expect big returns. So what should we make of the Bank of Canada’s rush to embrace and preach the doctrine of slow growth?
By Ian McGugan

Don’t hurry, be happy: Bank of Canada Governor Stephen Poloz says boards and management should adjust their expectations to accept slower growth and modest returns

Senior executives have one overwhelming goal, at least so far as shareholders are concerned, and that goal is to create decent returns on the money invested in their companies. But what constitutes a reasonable profit in this age of low growth? According to the Bank of Canada, a 4% payoff should be enough to satisfy anyone.

Boards of directors will beg to differ. So will investors. And so will this column.

Experience suggests most people expect returns for putting their money at risk to be much, much larger than 4%. In Canada, 4% is what most banks and telecom companies pay as a dividend, but most shareholders also presume there will be substantial growth in the share price on top of that. Yet Bank of Canada Governor Stephen Poloz says folks who are counting on such big returns are being unrealistic.

In a speech in September, he urged his audience to wake up and smell the slow-growth coffee. “I have had some business leaders tell me that they have been surprised to see, for example, companies in Asia pursuing investments with implicit returns of around 3 to 4%, well below most companies’ hurdle rates,” he said. “My response has been to say that in the current and prospective environment, 4% will probably turn out to be a pretty good return.”

Really? Is a miserly 4% return on risky new ventures all we can reasonably expect from the future? Poloz is a smart man with a PhD in economics and a staff of expert forecasters at his disposal; he’s not throwing around opinions lightly. Yet his advice is quietly revolutionary.

Among other things, his forecast for paltry returns on capital projects suggests that he sees interest rates continuing to hover around historical lows for a long time. (In recent decades, investors have typically demanded a three-percentage-point premium for putting their money in stocks rather than bonds, so 4% returns on equity investments imply roughly 1% returns on 10-year government bonds.) Since low bond yields are nearly always associated with slow economic growth, Poloz is really urging us to brace for a disappointing future in which rewards will be meager by historical standards.

He may be right. But his take on matters is also open to debate.

Before we accept Poloz’s 4% doctrine as gospel, we should examine the Bank of Canada’s reasoning more closely. In recent speeches, Carolyn Wilkins, the senior deputy governor at the central bank, has stressed two key reasons for slow growth—our aging demographics and our disappointing productivity gains. Neither trend is limited to Canada but both are being felt here, she says.

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The demographic argument is simple to understand: it’s the idea that an aging population acts as a brake on economic growth. The number of prime-age workers in Canada raced ahead at 3% a year in the late 1980s; today the growth rate of that population is just a whisker above zero. A diminishing supply of new workers restricts the potential ability of the economy to expand output, Wilkins says (see accompanying chart).

The productivity argument is a bit more mysterious. Labour productivity is the amount of output a worker can produce with an hour of work. It grows if businesses are willing to invest in new machinery and other tools that can boost how much output a worker can produce per hour. But productivity is also tied to technological innovation in ways no one is very good at predicting. The spread of computers, for instance, seemed to have little effect on productivity through the 1970s and 1980s. Then, suddenly, in the 1990s, productivity jumped in ways that seemed to reflect the growing impact of information technology.

Since 2000, productivity growth has disappointed. “The effects of the information technology revolution on productivity growth are fading and the rate of adoption of new technologies is slowing,” Wilkins said. “An additional source of drag has come more recently from a significant slowdown in business investment which is in large part related to lingering uncertainty and a steep decline in global trade growth.”

Her comments add up to a bleak picture of the present and future. But the more you think about her points, as well as Poloz’s 4% doctrine, the more the pessimism seems a mite overdone.

For instance, is demographics really a large factor in the current slowdown? Sure, it’s clear that a declining supply of prime-age workers imposes an upper speed limit on economic growth—but at the moment we’re not even using all the prime-age workers we have. Unemployment is running higher than we would like, and wage growth has been mediocre, indicating that employers aren’t being forced to go to great lengths to attract workers. Demographics may eventually be a limiting factor on how fast we can expand the economy. Right now, though, it seems premature to blame the slowdown on an aging population.

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Then there’s productivity growth (see accompanying chart). The past few decades demonstrate nobody can forecast productivity’s ups or downs. It therefore seems defeatist to simply extrapolate the current slowdown indefinitely into the future. Productivity may worsen; it could also get much better depending on how technology develops.

So why is the Bank of Canada rushing to both embrace and preach the doctrine of slow growth? It may be that it wants to signal its weapons are largely exhausted. Barring negative interest rates or quantitative easing—both of which would be a shock to Canadians—monetary policy is out of ammunition.

But that still leaves fiscal policy. Today’s low interest rates are a powerful argument for more public spending. Granted, it’s not the job of the central bank to preach to elected officials about the merits of more public spending to increase demand and boost growth. It is an issue, however, that it should highlight more prominently before prematurely condemning us to a future of 4% returns.

Ian McGugan is an award-winning business journalist in Toronto and the founding editor of MoneySense magazine. E-mail: imcgugan4@gmail.com.

Photography: Chris Wattie, Reuters

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