From the Fraser Institute

By Steven Globerman

Political developments in the U.S. over the past few years have substantially increased the risk of any investment that relies on unrestricted access to the U.S. market

Last week, the Trudeau government and the Ford government announced a new multi-billion dollar taxpayer-funded subsidy for Honda to expand its Alliston, Ontario plant to manufacture electric vehicles (EV) and host a large EV battery plant. Eventually, the direct and indirect subsidies could total $10 billion from the two governments.

The Honda announcement follows earlier deals with Northvolt, Stellantis and Volkswagen to build and operate EV battery and auto assembly plants in Ontario. According to the Parliamentary Budget Officer, these three deals may total $50.7 billion after accounting for the cost of government borrowing to finance the subsidies and foregone corporate tax revenue from tax abatements tied to production.

Clearly, if future taxpayers across the country (not just in Ontario) are to avoid a huge additional tax burden or suffer reductions in government services, a lot needs to go right for Canada’s EV industry.

In particular, there must emerge sufficient market demand for EVs so these “investments” in the EV auto sector will be fully paid for by future tax revenues from corporate and personal income taxes levied on companies and workers in the EV sector. During their joint announcement of the Honda deal, both Prime Minister Trudeau and Premier Ford ignored this elephant in the room while claiming that the Honda deal will mean 240,000 vehicles a year manufactured at the site and 4,200 jobs preserved, while adding another 1,000 jobs.

By way of perspective, in 2023 around 185,000 EV vehicles were sold in Canada—about 11 per cent of all new cars sold in Canada that year. This is considerably less than the target capacity of the Honda complex and the total expected production capacity of Canada’s EV sector once all the various announced subsidized production facilities are in operation. In contrast, 1.2 million EVs were sold in the United States.

The demand for EVs in Canada will likely grow over time, especially given the increased incentive the federal government now has to ensure, through legislation or regulation, that Canadians retire their gas-powered vehicles and replace them with EVs. However, the long-run financial health of Canada’s EV sector requires continued access to the much larger U.S. market. Indeed, Honda’s CEO said his company chose Canada as the site for their first EV assembly plant in part because of Canada’s access to the U.S. market.

But political developments in the U.S. over the past few years have substantially increased the risk of any investment that relies on unrestricted access to the U.S. market. The trade protectionist bent of Donald Trump, the Republican nominee in the upcoming presidential election, is well known and he reportedly plans to impose a broad 10 per cent tariff on all manufactured imports to the U.S. if elected.

While the Canada-U.S.-Mexico Free Trade Agreement ostensibly gives Canadian-based EV producers tariff-free access to the U.S. market, Trump could terminate the treaty or at least insist on major changes in specific Canadian trade policies that he criticized during his first term, including supply management programs for dairy products. The trade agreement is up for trilateral review in 2025, which would allow a new Trump administration to demand political concessions such as increased Canadian spending on defence, in addition to trade concessions.

Nor would the re-election of President Joe Biden immunize Canada from protectionist risks. Biden has been a full-throated supporter of unionized U.S. auto workers and has staked his administration’s legacy on the successful electrification of the U.S. transportation sector through domestic production. Given his government’s financial commitment to growing a domestic EV sector, Biden might well impose trade restrictions on Canada if Canadian exports start to displace domestic production in the U.S.

In short, Canadian politicians, most notably Justin Trudeau and Doug Ford, have staked the future of Canada’s heavily subsidized domestic EV sector on the vagaries of the U.S. political process, which is increasingly embracing “America First” industrial policies. This may turn out to be a very costly gamble for Canadian taxpayers.

From the Fraser Institute

By Steven Globerman

In the minds of most Canadians, there’s little connection between housing affordability and productivity growth, a somewhat wonky term used mainly by economists. But in fact, the connection is very real.

To improve affordability, the Trudeau government recently announced various financing programs to encourage more investment in residential housing including $6 billion for the Canada Housing Infrastructure Fund and $15 billion for an apartment construction loan program.

Meanwhile, Carolyn Rogers, senior deputy governor of the Bank of Canada, recently said weak business investment is contributing to Canada’s weak growth in productivity (essentially the value of economic output per hour of work). Therefore, business investment to promote productivity growth and income growth for workers is also an economic priority.

But here’s the problem. There’s only so much financial capital at reasonable interest rates to go around.

Because Canada is a small open economy, it might seem that Canadian investors have unlimited access to offshore financial capital, but this is not true. Foreign lenders and investors incur foreign exchange risk when investing in Canadian-dollar denominated assets, and the risk that Canadian asset values will decline in real value. Suppliers of financial capital expect to receive higher yields on their investments for taking on more risk. Hence, investment in residential housing (which the Trudeau government wants to promote) and investment in business assets (which the Bank of Canada warns is weak) compete against each other for scarce financial capital supplied by both domestic and foreign savers.

For perspective, investment in residential housing as a share of total investment increased from 22.4 per cent in 2000 to 41.3 per cent in 2021. Over the same period, investment in two asset categories critical to improving productivity—information and communications equipment and intellectual property products including computer software—decreased from 30.3 per cent of total domestic investment in 2000 to 22.7 per cent in 2021.
What are the potential solutions?

Of course, more financial capital might be available at existing interest rates for domestic investment in residential housing and productivity-enhancing business assets if investment growth declines in other asset categories such as transportation, roads and hospitals. But these assets also contribute to improved productivity and living standards.

Regulatory and legal pressures on Canadian pension funds to invest more in Canada and less abroad would also free up domestic savings for increased investments in residential housing, machinery and equipment and intellectual property products. But this amounts to an implicit tax on Canadians with domestic pension fund holdings to subsidize other investors.

Alternatively, to increase domestic savings, governments in Canada could increase consumption taxes (e.g. sales taxes) while reducing or even eliminating capital gains taxes, which reduce the after-tax expected returns to investing in businesses, particularly riskier new and emerging domestic companies. (Although according to the recent federal budget, the Trudeau government plans to increase capital gains taxes.)

Or governments could reduce the regulatory burden on private-sector businesses, especially small and medium-sized enterprises, so financial capital and other inputs used to comply with often duplicative or excessive regulation can be used to invest in productivity-enhancing assets. And governments could eliminate restrictions on foreign investment in large parts of the Canadian economy including telecommunications, banking and transportation. By increasing competition, governments can improve productivity.

Eliminating such restrictions would also arguably increase the supply of foreign financial capital flowing into Canada to the extent that large foreign investors would prefer to manage their Canadian assets rather than take portfolio investment positions in Canadian-owned companies.

Canadians would undoubtedly benefit from increases in housing construction (and subsequently, increased affordability) and improved productivity from increased business investment. However, government subsidies to home builders, including the billions recently announced by the Trudeau government, simply move available domestic savings from one set of investments to another. The policy goal should be to increase the availability of risk-taking financial capital so the costs of capital decrease for Canadian investors.