User:19iaboulnaga/Economy of Canada

Canada's economy is highly developed and succeeds in accomplishing many of the following four macroeconomic goals: low and stable rate of inflation, stable economic growth, low unemployment rate, and equitable distribution of income. The government has policies in place to address each of the goals, which have been very effective in working towards the former three and somewhat effective in working towards an equitable income distribution. The government has recently made efforts to improve its progress on the latter goal, and it remains to be seen whether the changes have been effective.

Inflation

The effect of changing interest rates on inflation in an economy

Since 2012, Canada’s inflation rate has remained low and stable, remaining between around 1% and 2% annually. Most recently, in April 2018, the annual inflation rate was measured at 2.2%. The Bank of Canada has set the target rate at 2%, high enough to encourage economic activity through consumption and business investment without reducing the currency's value^[2], so Canada is succeeding in maintaining their ideal level of inflation. The government uses monetary policy to control the inflation rate - the central bank, the Bank of Canada, changes its short-term interest rates in response to changes to the inflation rate above or below the target inflation rate. For example, if the inflation rate is below the target, the central bank would reduce interest rates to encourage borrowing and spending, increasing aggregate demand and causing inflation. If the inflation rate was above the target, they would increase interest rates to have the opposite effect, decreasing aggregate demand and causing deflation.

The graph to the right demonstrates the effects that changing interest rates would have on an economy. Reducing interest rates would encourage consumers and firms to borrow and spend more money, increasing aggregate demand from AD1 to AD2. This change increases inflation as the price level increases from P1 to P2. Increasing interest rates instead would discourage borrowing, decreasing aggregate demand from AD1 to AD3 and decreasing inflation as the price level decreases from P1 to P3.

Economic growth

Canada's GDP over time from 1960 to 2016, adjusted for inflation

After reaching its short term peak in GDP in 2013, the Canadian economy entered a recession, experiencing negative economic growth over three years until 2016^[3]. However, the GDP growth rate has gradually improved and the economy reached its short term low, or trough phase, in 2016 - projections indicate that the GDP began to grow after 2016^[4][5]. This pattern of rebounding growth and recession is not a concern, as it follows the predictable inflation and deflation patterns of the natural business cycle, and Canada is succeeding in maintaining a trend of stable upward growth. From 2016 to 2018, GDP growth rates have remained mostly positive, measured at a steady 0.4% per quarter for the last two quarters of 2017^[6]. The Canadian government is working to stimulate economic growth with its Hamburg Growth Strategy^[7]. This plan includes the Innovation and Skills plan for training labourers, which will increase the quantity and quality of labour in the country, improving output efficiency and aggregate supply. It also includes a $1.3 billion investment into public infrastructure and transportation, which would increase aggregate demand via government spending on a merit good for society, both causing economic growth.

Projected effects of the Hamburg plan, causing economic growth

This economic growth is visible on the diagram to the right: the increase in productivity shifts aggregate supply from AS1 to AS2, and the increase in aggregate demand from AD1 to AD2 with increased investment causes economic growth as the level of output increases from Y1 to Y2.

Unemployment rate

The unemployment rate in Canada has been steadily declining over the past decade, reaching the lowest level in over 40 years at 5.7% in December of 2017^[8], with the unemployment rate at 5.8% by the most recent measures in April 2018^[9]. This rate quite low and close to ideal - some unemployment will be present even in healthy economies due to natural causes of unemployment such as frictional or structural unemployment. As the Canadian economy grows and inflation occurs, either naturally or due to government policies like monetary policy by the Bank of Canada, unemployment will naturally decrease, since greater output levels necessitate more employment. Certain other government policies also contribute to a reduction in unemployment rates: an Ontario policy requires that “all businesses with more than 20 employees to hire at least one additional person with a disability^[10].” This policy aims to reduce the especially high unemployment rate for people with disabilities, who are unemployed at a rate of 16% - more than twice the national rate^[11].

Equity in income distribution

A Lorenz curve model showing the distribution of wealth among different income levels in Canada^[18]

Canada’s income inequality has been rising over the past two decades^[12]. According to most recent measures, Canada’s Gini coefficient - a measure of the wealth distribution in a country, with 1 being the most unequal and 0 being the most equal - reached its highest level in 2013 at, 0.34^[13]. Compared to peer countries such as Sweden and France, which tend to have Gini coefficients between 0.2 and 0.3, this means that Canada has moderate income inequality. Some income inequality is necessary to serve as an incentive for people to pursue more difficult, higher paying jobs, but this high level of inequality indicates a problem of inequity, where the income distribution is unfairly skewed towards higher income earners. Canada has policies in place aiming to reduce income inequality such as a progressive structure of direct taxes, where higher income earners pay more taxes on their income, and the revenue from those taxes is then redistributed to benefit lower income earners.

Solution to improve equity in income distribution

Of the four major macroeconomic goals, Canada needs most to address its problem of inequity in income distribution. Canada’s GINI coefficient is high compared to those of comparable countries at 0.34, and the wealth is very concentrated in the top quintiles of the Canadian population. In 2016, the top 20% of the population owned over 67% of the wealth, and the top 1% alone owned 11.2% of the country’s total income in 2015^[14]. To improve equity in income distribution, Canada currently has a progressive tax structure of direct taxes in place, where the lowest earners are taxed 15% on their income and the highest are taxed 33%^[15]. This structure was recently modified to better benefit middle class earners with the move from the previous Harper plan to the Trudeau plan for taxes, lowering the tax rate for the middle class from 22% to 20.5% and increasing taxes for the top 1% of taxpayers^[16]. The government’s revenue from this tax plan is then redistributed for the benefit of lower income individuals through programs such as the direct provision of merit goods like healthcare^[17] and through investments into public services like transportation.

Projected effects of progressive tax plan and redistribution

This plan works to reduce income inequality and promote equity and simultaneously works towards the other macroeconomic goals. A progressive tax structure generates much more government revenue than other tax structures, supplying the government with more money to spend on public services and redistribution. Directly providing merit goods and providing access to public services for low income earners significantly improves their quality of life and ensures they have access to many necessities such as food, education, and healthcare. Along with the humanitarian benefits, this also allows them to be better and more productive members of the labour force, increasing the country’s productive capacity and its aggregate supply. In addition, large portions of the money earned by high income earners goes unspent - as income increases past a certain point, their consumption reaches a limit while their income continues to grow, so they opt to put the extra money into savings or investments. Taxing this income and spending it through redistribution policies increases aggregate demand and better stimulates the economy. These increases in aggregate supply and demand would lead to economic growth, and may lead to deflation in the economy.

On the graph to the right, the increase in aggregate supply from AS1 to AS2 and increase in aggregate demand from AD1 to AD2 lead to economic growth as the level of output increases from Y1 to Y2, leading also to a reduction in unemployment as more labour is required to produce a higher output. These shifts may also lead to deflation - if the shifts occur as pictured, with the increase in aggregate supply being more significant than the increase in aggregate demand, the price level would decrease from P1 to P2.

The Laffer Curve^[19]

However, implementing a progressive tax structure can lead to some disadvantages for society and the economy. First, the process of collecting and redistributing the tax money requires labour to carry out, meaning the government will have to pay some administrative costs to these labourers. This creates some opportunity cost for the government as the money from those administrative costs cannot then be spent on other services for society. Second, some level of income inequality is necessary in an economy to serve as an incentive for people to pursue higher skill jobs that offer higher pay. If the tax rates for high income earners are too high, people that could have worked the more difficult jobs may decide that the amount of extra income they get to keep from working those jobs would be too small to justify the increase in difficulty. This reduction in the quality of labour would lower the nation’s productive capacity and lead to negative economic growth and increased unemployment. This would actually reduce tax revenue as fewer people would have high paying jobs that would pay high taxes. Therefore, the specific tax rates imposed on each bracket should be carefully monitored and adjusted to maximize the benefit while avoiding this reduction in efficiency. This concept is reflected in the theory of the Laffer Curve, which models that past certain tax rates, tax revenue will begin to decrease rather than increasing. It may also be true that Canada's current high-income tax rates are not high enough to maximize tax revenue and equity, and should be increased further. This is likely true, since the magnitude of the difference in income for the lowest and highest income earners means that there would still be ample incentive for people to take higher paying jobs if tax rates were slightly higher.

References

1. "Canada Inflation Rate." Trading Economics, 2018, tradingeconomics.com/canada/inflation-cpi. Accessed 23 May 2018.
2. "Monetary Policy." Bank of Canada, www.bankofcanada.ca/core-functions/monetary-policy/. Accessed 23 May 2018.
3. "Canada." The World Bank, World Bank Group, 2018, data.worldbank.org/country/canada?view=chart. Accessed 23 May 2018.
4. "Canada: Gross domestic product (GDP) in current prices from 2012 to 2022 (in billion U.S. dollars)." Statista, Apr. 2018, www.statista.com/statistics/263574/gross-domestic-product-gdp-in-canada/. Accessed 23 May 2018.
5. "Canada GDP." Trading Economics, 2018, tradingeconomics.com/canada/gdp. Accessed 23 May 2018.
6. "Canada GDP Growth Rate." Trading Economics, 2018, tradingeconomics.com/canada/gdp-growth. Accessed 23 May 2018.
7. "2017 Growth Strategy – Canada." Global Affairs Canada, Government of Canada, July 2017, international.gc.ca/world-monde/assets/pdfs/Canada-2017-Hamburg-Growth-Strategy_eng.pdf. Accessed 23 May 2018.
8. "Canada Jobless Rate Declines to Lowest in Over 40 Years." Trading Economics, 2018, tradingeconomics.com/articles/01052018133824.htm. Accessed 22 May 2018.
9. "Canada Unemployment Rate." Trading Economics, 2018, tradingeconomics.com/canada/unemployment-rate. Accessed 22 May 2018.
10. "Ontario's new employment strategy aims to reduce unemployment for Canadians with disabilities." National Post, Postmedia, 5 June 2017, nationalpost.com/news/politics/ontarios-new-employment-strategy-aims-to-reduce-unemployment-for-canadians-with-disabilities. Accessed 22 May 2018.
11. "Ontario's new employment strategy aims to reduce unemployment for Canadians with disabilities." National Post, Postmedia, 5 June 2017, nationalpost.com/news/politics/ontarios-new-employment-strategy-aims-to-reduce-unemployment-for-canadians-with-disabilities. Accessed 22 May 2018.
12. "GINI index (World Bank estimate)." The World Bank, 2013, data.worldbank.org/indicator/SI.POV.GINI?locations=CA. Accessed 22 May 2018.
13. "Income Inequality." The Conference Board of Canada, 2018, www.conferenceboard.ca/hcp/Details/society/income-inequality.aspx. Accessed 22 May 2018.
14. "Canada’s top 20% own over 67% of the wealth." National Union of Public and General Employees, 2018, nupge.ca/content/canada%E2%80%99s-top-20-own-over-67-wealth. Accessed 23 May 2018.
15. "Canadian income tax rates for individuals - current and previous years." Government of Canada, www.canada.ca/en/revenue-agency/services/tax/individuals/frequently-asked-questions-individuals/canadian-income-tax-rates-individuals-current-previous-years.html. Accessed 23 May 2018.
16. Dion, Stéphane. "Trudeau’s Plan for the Middle Class Will Reduce Inequality in Canada." Liberal, Liberal Party of Canada, 22 July 2015, www.liberal.ca/trudeaus-plan-for-the-middle-class-will-reduce-inequality-in-canada-stephane-dion/. Accessed 23 May 2018.
17. "Canada's Health Care System." Government of Canada, www.canada.ca/en/health-canada/services/health-care-system/reports-publications/health-care-system/canada.html. Accessed 23 May 2018.
18. "Lorenz curve for Canada share of total income." Feb. 2000. ResearchGate, 2000, www.researchgate.net/figure/Lorenz-curve-for-Canada-share-of-total-income_fig5_5040968. Accessed 23 May 2018.
19. Laffer curve. Wikipedia, Wikimedia Foundation, 19 May 2018, en.wikipedia.org/wiki/Laffer_curve. Accessed 23 May 2018.