Stephen Poloz: ‘No one wins a trade war. Everybody loses.’

A Q&A with the Bank of Canada governor about rising protectionism, soaring house prices and why he isn’t convinced the economy has turned a corner

Stephen Poloz, Governor of the Bank of Canada. (Photograph by Jaime Hogge)

Stephen Poloz, governor of the Bank of Canada. (Photograph by Jaime Hogge)

On March 28, in commemoration of Canada’s 150th birthday, Bank of Canada Governor Stephen Poloz gave a speech in his hometown of Oshawa, Ont., exploring the evolution of Canada’s economy over the past two centuries. It was, in short, an ode to Canada’s openness to globalization at a time when populist sentiment against free trade and immigration is on the rise. Maclean’s spoke with Poloz after his speech.

Q: You argue that openness to trade, capital and people has held Canada in good stead throughout its history. For those who didn’t hear you speak, is there a moment you looked at that is especially relevant to the world we face now?

A: The most intense period when Canada really made it big was just after the war.  You had massive investments in infrastructure accompanied by the baby boom, immigration and this pursuit of openness, which Canada really was a guiding light on, intellectually.

In Canada there’s a deep understanding that we’re small but big, and in order to succeed in the world we need to create economies of scale somehow.  The only way you can do that is through openness to the rest of the world both for capital, for people and for sales.

Q: Is that the role you see Canada playing now—a guiding light on free trade? Is anyone listening?

A: Certainly. And frankly I think in places like the G20, where I was just a week or so ago, there was a great deal of discussion around those core beliefs and the benefits we’ve all enjoyed and what kinds of risks would be taken by disregarding [them].

The deeper you dig into these trading relationships, the more complex you discover they are, and how easily they could be disrupted.

Q: What worries you most about what you’re seeing?

A: There’s a misunderstanding of how trade has benefited us in the past. Partly it’s because we’ve been in a relatively free, liberalized world for some time. There’s a tendency for the benefits to be taken for granted. Some of the things that are being talked about would cause a significant reversal in those gains.

I’m sure that the people who put huge tariffs in place in the early days of the Depression in the ’30s thought they were doing the right thing. But I think hard lessons have been learned.  We shouldn’t make those kinds of mistakes again. No one wins a trade war. Everybody loses.

READ MORE: Stephen Poloz on the economy: ‘It’s not time to call out the band’

Q: You’ve argued that what is driving protectionist forces is not trade itself, but technological disruption.      

A: Yes, I believe that. Those who have lost their jobs in manufacturing would possibly point to trade as one of the reasons—less-expensive labour in another country. Of course, as with anything, there is some truth to this. It’s undeniable that it’s competitive. But looking at it more objectively, the vast majority of job losses have been technological.

I’m pretty sure no one would think about rolling back technology in order to prevent those kinds of job losses. It would be like back in the old days, saying we can’t possibly license automobiles because horse whip makers would lose their jobs. Yet they would consider rolling back some of the benefits of trade. That would be using a very risky kind of solution to one problem that’s big for some people but small on a macro [scale] and causing all kinds of other repercussions for everyone.

Q: I want to ask about something that’s dogged you a lot lately—the gap between the optimism among private-sector economists and your more downbeat view of Canada’s economy. What would it take for you to share their enthusiasm for the recent bout of positive economic news?

A: I’m always happier to get a good number than a bad number. In the past few months, we’ve had a few good numbers, but not universally so.

We had a fourth-quarter GDP number that was stronger than most of us had pencilled in. On the surface, that sounds good. You look beneath the surface and you discover it’s not actually in sustainable categories. Investment, hugely important for Canada, was still negative. Exports were okay but not great. The core drivers are still lacking, and the things we know don’t have staying power—such as consumption and housing—were the surprise factors.

You have to look through that and say, well, it’s not time to call out the band. We’ve got quite a way to go before we use up our excess capacity. Importantly, we need the government’s infrastructure program to contribute a great deal to that. Without that, we won’t close the output gap.

More from our Q&A with Stephen Poloz:

Q: You used to say Canada needed fiscal stimulus to go along with monetary stimulus. Now we’ve got $140 billion of accumulated deficits on the horizon. Are we getting our money’s worth on that yet?

A: I’ve seen the various announcements of where that money is going, and much of that is a productivity-enhancing investment that can only boost our trend line. It’s not about sending money out the door so it boosts the economy temporarily, but putting it out in a form that invests in the future, that gives you 30, 40, 50 years’ worth of use out of a bridge or what have you.

There’s also the social infrastructure side, which doesn’t get much credit. One of our weaknesses is labour force participation by women. If you can make more investments in the social infrastructure side that boost by two or three points the participation rate of women, that can have an amazing effect on the potential growth for the economy.

All these investments can pay off very long term, and I have every confidence the things that are being done will work in that direction. We have to be patient because they work through an important machinery, but since it’s an investment, you’re going to get the benefits at some point.

Q: What effect has the uncertainty over NAFTA’s future had on businesses?

A: Some negative risks are virtually impossible to quantify, yet you know they would be big and negative. Even if nothing happens over the next year, that’s just another year of not knowing. If you’re a business thinking about expanding, will you do it?  Some businesses will; others won’t.

It seems to be a layer of uncertainty that’s holding people back, which has been true before, after the legacy of the global financial crisis and the great recession left a lot of companies cautious. They need more convincing that it’s time to invest. My goodness, even if we allow for the drop in investment in the energy sector, the rest of the economy has also been declining in investment.

It’s part of the headwinds that we face, and it’s why interest rates are where they are, to help offset some of that as best we can.

Q: The Bank of Canada’s argument used to be that business investment would at some point take the load off households for carrying the economy. That never happened. But you’ve started talking more about services doing that. Why will services will be able to do what non-energy exports and business investment couldn’t?            

A: First of all, we haven’t given up on non-energy exports. They have recovered substantially from their lows and they are growing. Part of what we’ve done is dig down more deeply and discover that the leading growth sectors are actually brand new. That’s not too surprising, because when you have destruction like what we’ve had, it’s the other half of the process. Creative destruction.

That creative part is often something you hadn’t thought of before. It can be survivors that expand. That is occurring, but it’s a natural process that takes time. What is more exciting is that new sectors, particularly in services, are growing much faster than we expected.

They don’t require as much machinery and equipment and heavy-duty investment as a manufacturing company does. If that continues, you’ll converge on a place where the share of investment in the economy may still look low compared to what expectations were.

The point is that we shouldn’t be excessively discouraged at investments not leading the way. In IT services, you can create a company this afternoon with a dozen of your friends that are gee-whiz programmers and all they need is their laptops. The company is not investing big to set that up, but they’re out there creating new solutions for companies, and the companies buy it, and that’s investment.

Q: Listening to you it strikes me that the way we measure growth doesn’t reflect the way the economy is evolving.

A: I know StatsCan is always making its data better, and the more we go into services, the more difficulties you might face in collecting the data. For trade, it’s easy to count the stuff crossing the border because you used to have a tariff on it. Whereas services can just happen, and that’s why our monthly report on trade doesn’t have services—because it’s hard to [measure]. They wait until they have more information from other sources to put together the quarterly data, but it gets a lot less profile because the national accounts [GDP] come out that day.

Services are becoming a driving force for growth on the export side. We need to understand it better. I’m sure StatsCan over time will continue to improve those data.

Q: Should StatsCan be doing more sooner on that front?      

A: I’ve joked around about how I would love to have the monthly data on services. We get them for the U.S., so it is possible.  Of course, the question is then they’ll get revised a lot. It’s a trade-off. They’re the experts on that, not me. 

Q: Let’s talk about housing. How many times a day do you get asked about house prices?

A: Every time.

Q: In 2014, the bank raised some concerns that the housing market could be overvalued by 30 per cent. Since then, national prices are up another 25 per cent and Toronto’s up 35 per cent. What kind of overvaluation are we looking at now?

A: The bank has tried to be clear how hard it is to make such an estimate. The work you’re referring to was a research paper that one of our people wrote. That model they used—and that’s the magic word, it’s a model, so you know enough now to lower your trust factor. It’s important that it’s a piece of research that looks at housing markets worldwide and the ingredients that caused them to go overvalued and then to correct. Canada was just a couple of data points in there, whereas it was really about Hong Kong and Sydney and London and places like that.

The lesson we learned there is that by that metric, if we had overvaluations in some of those markets, we could use similar metrics in Canada. That’s where that number came from. I’m certainly not going to hang my hat on that number or even whether there is overvaluation.

I know intuitively it would seem there is, but the fact is that the fundamentals have all changed through that time, too. The greater Toronto economy is creating five per cent per year more jobs. Population growth is continuing to be strong. The same thing with Vancouver. That automatically generates more demand for housing at a time when there are constraints around supply.

I’m not saying supply is zero. Of course, there are new houses being built. It’s evident it’s not quite keeping pace with the demand. As any city gets bigger, prices automatically go up even if there are no more people. They just go up because it’s farther from the outside to the centre. You’re willing to pay a bit more to be closer. It’s a longer drive. These are just basic urban economic concepts.

To take all that and say, “Where do you think [the housing market is] going?”—it’s too hard to separate all those things. What concerns us would be if prices were seeing a speculative component—how much of buying and selling is speculative as opposed to just folks who want to own a house?

Q: So how much do you think speculation is driving the market?

A: That of course we don’t know, but the way prices are rising in Vancouver and certainly in Toronto, it would be really hard for me to construct a fundamental story to justify. You’re kind of left with [the idea that] some of that must be driven by extrapolated expectations. Every time you hear a story about somebody who bought a house, not living in it, just to sell it eight months or a year later, pay capital gains tax and still make out all right, that’s speculative—and in a way artificial—demand. Somebody looking for a house for real doesn’t get one until the price goes even higher.

These things have a life of their own. And a death of their own, because in the end you still have to buy the house. If the house becomes a certain number and you can’t get a mortgage big enough, you can’t buy it, unlike speculation in a financial market, which can go on almost without limit by comparison.

We just have to wait and see. The federal efforts have been about improving the quality of debt, because for us the concern is that if debt is unsustainable or fragile, the first negative shock that comes along can be magnified and make it much worse for the economy. Financial stability is the thing we’re tackling, and whether prices go up or down after you’ve changed the rules around mortgages is not relevant for that policy. That policy is not designed to somehow control the housing market.

Q: Does the Bank of Canada shoulder responsibility for the speculation we’re seeing in the market?

A: No. When you’re borrowing money to buy a house and you think you’re going to make 20 per cent over the next year, I don’t think it’s going to make a difference if the interest rate you’re paying is 2 per cent, 4 per cent or 6 per cent. It’s still an important capital gain. I would pretty well reject that. It’s not low interest rates that are fuelling speculation.

Q: The U.S. is on a path to higher interest rates. How long before the Bank of Canada feels pressure to follow suit? 

A: We have room to grow, certainly more than the U.S. has. We call that a divergence.  It’s not necessarily a growth divergence, but it’s a level divergence. It means we can grow faster on average than the U.S. for a while, while we use up that excess capacity. 

Q: Does that mean letting the Canadian economy run hot for a while?

A: It means that the Canadian economy needs to grow above its potential growth rate for a while to use up the excess capacity. Arguably, there’s more excess capacity than conventional measures would point to because we have lost some participation in the workforce over the course of this cycle, particularly among youth.

What we’re hoping is as the economy gathers momentum and uses up that excess capacity, it will draw those folks back into the workforce. For instance, about 120,000 people between 15 and 25 have withdrawn from the workforce. I know some of them are [at school]. That’s fine, but we want them to come back out and add to that potential line. Similarly for women and for adult men.

Q: Just one last question. I’ll use the same last question from when we talked in 2014. I asked you then, “If three years from now rates are still low and we haven’t seen the expected benefit, would it be time for a rethink?” You didn’t think we’d be in that situation, but here we are. Is there a point where there needs to be a rethink?

A: What you’re just proving for everybody is that I didn’t foresee the oil-price shock, which was an important delay in the path back home [to full capacity] that you and I talked about then. Arguably, we would have been there now just like the U.S. is, give or take.

But the setback from the oil price is pretty significant—more than $60 billion a year less income—and we’re still adjusting to that. The big negative part seems to be behind us. Now, as that bottoms, the rest of the economy is becoming more dominant. That process has to continue naturally, and I’m reasonably confident that if we sit down again in three years, as I hope we will, I’ll be saying that worked out okay.


This interview has been edited and condensed.



Stephen Poloz: ‘No one wins a trade war. Everybody loses.’

  1. Nowhere in this interview can one find the word “inflation” although Poloz is the governor of a central bank that ostensibly has an inflation targeting regime. Poloz has done what he could to emasculate his mandate to promote price stability. When he and Finance Minister Morneau signed the 2016 renewal of the inflation-control agreement he abandoned the CPIX as the operational guide for the Bank of Canada which more or less excludes mortgage interest costs for three new measures, none of which exclude mortgage interest. (More or less, because since the May 2011 CPI update, mortgage interest on secondary residences is part of the other owned accommodation expenses component of the CPI, and this is not an excluded item from CPIX. Governor Poloz could have and should have requested that StatCan provide the Bank of Canada with a special series for owned accommodation that excludes these mortgage interest costs) but low-energy Stephen couldn’t be bothered.) Governor Poloz’s favourite measure of underlying inflation, CPI_common, showed a ludicrously low inflation rate of just 1.3% in February 2016. You have to go all the way back to February 1995, in the aftermath of the terrible recession of the early 1990s to find a lower inflation rate for this series. Even the C.D.Howe Institute’s Monetary Policy Council, usually so non-judgmental, is concerned about this dysfunctional inflation indicator.
    No admission of blame by Poloz for the housing bubble that he has fed as governor. This could and probably will end in tears.

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