Notes for Mark Carney

History beckons

Congratulations on an impressive victory, Mr. Carney. This is a most difficult time to take the helm. But I am confident that no one is more prepared for the challenges Canada faces today than you.¹ There is a tendency for top leaders, who are immediately thrust into the thick of things, to lurch from crisis to crisis, and lose track of the deeper, slower-movings variables that control the long-term destinies of nations. This note is written in the hope that these easy-to-kick-down-the-road cans will still receive executive-level attention in your administration. A second reason is to write this dispatch is to discuss the extraordinary geopolitical responsibility that has been thrust on your shoulders; a responsibility that comes with great opportunity for you as a statesman and for Canada as a leading nation in the world. I’ll deal with them in order.

The Productivity Imperative

On almost any relevant policy horizon except the shortest, productivity is almost everything. It is the key to long-term growth, the standard of living of common people, and the status and global influence of a great nation.

There has been a marked slowdown of productivity growth in the core of the world economy. This slowdown is more pronounced outside the United States, where it has fallen from nearly 2 percent in 1999-2013 to a rate of 1.2 percent in 2014-2023. Europe and Canada were already growing slower than the US in the earlier period. They have fallen further behind. In the EU, it has fallen from 1.4 to 0.8 percent this past decade. In Canada, from 1.2 percent to 0.7 percent. [All data used in this post is from the OECD.]

Trend decline in labor productivity growth in Canada is in line with the rest of the G7 ex US. Reversing this decline should be the most important long-term objective of your administration.

The good news is that the slowdown in Canadian labor productivity growth is largely due to a slowdown in capital deepening rather than in underlying TFP growth—and the former is more susceptible to policy than the latter. While the growth rate of GDP per hour worked has slowed from 1.2 in 1999-2013 to 1.0 percent per annum in 2014-2023, TFP growth has actually picked up from 0.4 to 0.6 percent per annum. There is still a gap with the US, where the rates of both labor productivity growth and TFP growth remain higher than the rest of the G7.

Canadian TFP growth has held up better even compared to the United States. The trend (or slope against time) for Canada is +0.3% per annum; it is -0.8% for the US, and a really alarming -3.6% for the rest of the G7.

Labor productivity growth, of course, is the sum of TFP growth and that due to capital deepening. Canada has been doing okay so far when it comes to the former. But this is no reason to be sanguine. The goal should be to catch up with the US. But for decades now, the US has been pulling ahead.

When it comes to capital deepening, the US-Canadian gap is even larger. Canada has fallen behind really dramatically here. While the US has seen capital deepening slow down from nearly 4% per annum in 1999-2013 to 1.7% in 2013-2023, Canada has seen it crash from 2.9% to 0.9%.

Even more concerning is the decline in R&D, which has fallen from a rate of growth of 3% per annum in 1999-2013 to just 0.5% in 2014-2023. If this continues, Canada will absolutely not be able to keep up. In the advanced industrial core, firms close to the productivity frontier are those that spend the most on R&D, and it is R&D spending that ultimately controls which firms reach and stay at the productivity frontier. R&D works with longer and more variable lags than monetary policy. But it is the secret key to prosperity in the modern world economy.

The most dynamic industries are those where the ICT revolution has gone the furthest. Silicon Valley’s ecosystem of tech talent, venture capital and auxiliary services gives the US a decisive advantage. But the American advantage is now set to erode as foreign capital and talent, and perhaps even American capital and talent, flee the US in search of policy stability and competent government. Canada could be the big winner of this American self-goal.

At any rate, the Canadian combination of anemic capital deepening and R&D spending suggests that there are still many low-hanging fruit in the orchard. Moreover, it known that capex and R&D respond rapidly to policies like tax credits.² A policy mix that strongly incentivizes capex and R&D should yield large productivity gains for Canada.

This is not controversial, and I’m certain that I do not really need to persuade you regarding its importance to Canada’s future. But the question is one of priorities. I strongly recommend making a big push on the specific agenda of incentivizing investment and R&D in a bid to accelerate productivity growth. I also want to underline the importance of going big rather than small, on erring on the side of doing too much rather than too little.³ The potential payoffs of these policies are outsized compared to the costs and risks associated with them.

You need to go big or go home. This is not the Obama moment; this is the Carney moment in world history.

The Geopolitical Imperative

I understand that much of your time and attention will be devoted to the steady stream of innovations, escalations and tantrums from south of the border. But that makes it even more important to stay above the fray and look at the bigger picture. Yes, Canada is extremely exposed to the US. And yes, you will have to devote a lot of attention and effort to limit the damage from American instability. But soon as you lift your eyes and look elsewhere, opportunities lurk.

Canada is not alone. The Trump administration’s ham-handed attempt to extract tribute from former allies and partners has outraged everyone everywhere. Just like Canada, most of the world’s great nations are willing to stand up to his bullying. His attempt to reorder global economic relations has injected unprecedented volatility in the world. The US has flipped from being a global stabilizer to the principal source of disorder in the world. But the Europeans, the Chinese, and even the Japanese, are not willing to accept a fragmented, angry world where nations isolate themselves from each other in pursuit of fraudulent and discredited economic ideas and fantastical notions of national greatness.

Instead, the world over, I see great appetite and willingness to play positive-sum games even in the absence of American leadership. The Japanese have already told the Americans that they will not be decoupling with China. The Europeans are even further along that road. They’re actively working to rapidly reduce their security dependence on the US. I even hear talk, from Hélène Rey no less, of plugging the Kindleberger gap by having the euro replace the dollar in global financing and trade invoicing.

But reproducing a predictable world order that serves the common interest of nations and regulates international competition will be very hard given the persistent instability now emanating from the US. What it will require is far-reaching cooperation and, above all, leadership from real statesmen. Who will provide this leadership?

China and Europe are the big, anchoring poles of the emerging tripolar world. But neither is today in a position to set the global agenda and lead the world. The Chinese are not in position to lead because they do not enjoy the trust of the other major countries, who remain wary of Chinese intensions and concerned about Chinese commercial supremacy.

Nor is Europe in a position to lead at this time, for two reasons. First, because of the unfinished nature of the European project and attendant frictions, achieving a unity of purpose remains very hard on the continent. Second, they have to pay attention and devote considerable resources to the urgent matter of rapidly reducing their dependence on their security guarantor. With the war in Ukraine still on and with a resurgent Russian military, they have little choice but to prioritize security.

Nor is another non-polar state in a position to take up the slack. Everyone in the Western Pacific is fully absorbed by the challenge of managing the rise of China and the instability and erratic demands emanating from the principal security provider. Indian foreign policy remains sharply focused on securing their particular national interest. India is not even attempting to play a global agenda setting role. Nor does anyone else in the Global South have both the authority or the inclination to take up the slack opened up by the America’s inward turn.

You, on the other hand, Mr. Carney, are in almost a unique position in the international system to set the global agenda. You enjoy great authority and respect in the world. When you speak, all serious people listen carefully. No member of the global system, not even Japan, is as liked and as admired as Canada. Crucially, Canadian leadership changes the character of what would otherwise be a largely Eurasian resistance to American domination into something closer to a global accord to reproduce a legitimate global order.

The time is ripe for you to take up the mantle of global leadership. This will require a lot of legwork and persistent engagement. What makes the job doable is the fact that there is already considerable agreement on the main questions: on the need to maintain the open global order, on policy coordination to deal with the global recession that is in the offing, and on global cooperation with regard to slower-moving global challenges, above all, the climate crisis and development finance.

There is a tendency emanating from Europe that says ‘we can’t afford the luxuries of the climate fight and global development right now; we gotta prioritize security.’ Your job, Mr. Carney, is to remind them: ‘No, guys: we must recognize that our joint security and prosperity depends on much more than military security alone. It depends on the stability and openness of the world economy, on stable and predictable relations between the major countries, on global cooperation and respect for rules and norms. If these break down under the onslaught of egotistic revisionism and autocratization, we will have neither prosperity nor security.’

This will not be the first time in history that leadership of the system has passed to the smallest of the leading powers. For many decades after Napoleon, it was not Russia or Britain, but von Metternich of Austria-Hungary who set the European agenda and provided leadership in the Concert.⁴ The hour calls for a statesman of that stature. This is the responsibility history has thrust on your shoulders, Mr. Carney.

1. I am a quant based in New York but I did my PhD in math at McGill in Montreal, and retain a great deal of respect and fondness for Canada.

2. Akcigit et al. (2021) show that R&D tax credits introduced by the Reagan administration is 1981 were extremely effective in accelerating the rate of innovation and therefore productivity growth. The market failure addressed by these policies is due to the fact that firms underinvest in R&D because they not internalize the gains made in the future by those who build on their work. Working in an open economy framework, they also show that the optimal unilateral tariff rate is zero. See this viral twitter thread where I highlight some of their results.

3. Akcigit et al. (2021) show that the Reagan tax credits should’ve been 2-3 times as large. And on the risks of going to small, who can forget the Obama stimulus package? Even though it was the largest fiscal stimulus package ever passed at the time, economists have long understood that it was too small given the scale of the Great Recession.

4. See the magisterial monograph by Paul W. Schroeder (1962). Metternich's Diplomacy at its Zenith, 1820-1823.