Bank of Canada

09/11/2020 | Press release | Distributed by Public on 09/11/2020 08:19

The Canadian corporate investment gap

'You can clear your driveway faster with a snowblower than with a shovel.' This analogy, recently made by the Bank of Canada's Senior Deputy Governor Carolyn A. Wilkins, illustrates how business investment increases workers' productivity and the standard of living of Canadians. By investing in a snowblower, you could earn more money with the time saved clearing snow-perhaps by snowblowing more driveways-or you could have more time to spend on a leisurely activity of your choice.

But in the period after the financial crisis of 2007-09, business investment was lower than expected both in Canada and abroad. Several structural factors can possibly explain this lower investment (Barnett and Mendes 2017).

One is that firms may forego investment opportunities when they are unsure about future demand for their products (Leboeuf and Fay 2016). A drop in oil prices, for instance, creates uncertainty about future cash flows and also reduces the profitability of current and future investments in the oil sector.

Another factor could be an inability to finance firm investment. A firm may want to invest but may not have access to funding. Imagine wanting to buy a car to get to work faster but not being able to borrow money to buy it. You could only buy the car after you've earned the money to do so. And after buying the car, you may hold more cash to deal with emergency repairs. In the same way, a firm that has no access to financing can only invest after it has earned the funds, and it is more likely to stockpile cash.

In this note, we do not try to pin lower investment on one specific reason. Rather, we quantify how much investment behaviour has changed since the 2007-09 crisis. Then, we discuss a few of the potential reasons for this change that could be explored in future research.

We find that from 2008 to 2017, firms invested about $100 billion less than our model of their pre-crisis behaviour suggests they would have. This cumulative investment gap is economically significant-it represents about $2,700 less spent in investment on a per capita basis. Since Canada's gross domestic product (GDP) and productivity increase when firms invest more, understanding the nature of this investment gap is important for Canadians.