[This is a guest post by Hashmat Khan of Carleton University and Nyamekye Asare of the University of Ottawa.]
Can policies stimulating private investment deliver higher employment? Maybe, but investment and employment have become disconnected recently in Canada.
John Taylor has noted a strong negative correlation between investment and the unemployment rate, and argued that higher investment is the best way to reduce unemployment. Paul Krugman has questioned the direction of this causality, and the Canadian evidence seems to be somewhat supportive of his position.
The issue of causality aside, a reduction in the unemployment rate does not necessarily lead to an increase in employment, because the unemployed may stop looking for work and leave the labour force. For this reason, economists pay attention to the employment-to-population ratio as a better gauge of labour market conditions (see for example this post by David Andolfatto, and this Maclean’s Econowatch piece by Stephen Gordon). In this post, therefore, we highlight the relationship between investment and the employment-to-population ratio for Canada.
Starting with the financial crisis period: between the first quarter of 2008 and the last quarter of 2010, the employment-to-population ratio in Canada fell by 2 percentage points (63.7% to 61.7%) and, since then, it has remained approximately flat (See Figure 1). Meanwhile, the business fixed investment relative to GDP ratio fell by 2 percentage points (19.5% to 17.5%) from 2008 to 2009, but by the fourth quarter of 2013 it was back to the pre-financial crisis level of 19.5%.
It is well known that the Canadian economy weathered the financial crisis of 2008-09 better than the US and European countries, and also in comparison to our own recent history. The decreases in the employment ratio during the recessions of early 1980s and early 1990s were twice as large. The investment ratio also fell by 4 percentage points in the early 1980s, and by slightly over 2 percentage points in the early 1990s.
Although the two ratios tend to move together during downturns in Canadian economic activity, the interesting feature to note is their joint movement during the recovery phase. In particular, starting from the mid-1990s onwards, the two ratios appear to be more disconnected relative to the late 1980s period.
Figure 1: Data source: Statistics Canada CANSIM Tables 282-0087 and 380-0064. Employment is number of civilians/non-institutionalized people for the reference week that either worked for pay/profit or had a job but was away from work due to illness, disabilities, or other reasons. Population for Canada is 15+. I /GDP is computed as the ratio of nominal business fixed investment and nominal chain-weighted GDP. All data are seasonally adjusted.
Figure 2 reports the 10-year rolling correlation between the two ratios, starting in 1981. Between 1995 and 2006, the correlation fell from 0.9 to under 0.4, it then rose back up to 0.8 but from 2010 onwards it has steadily declined. At the moment, the correlation is at its lowest point of about 0.3, suggesting that the disconnect between the employment and the investment ratios is currently the greatest. To what extent is this disconnect a hindrance for economic policies is an open question at the moment.
Figure 2: 10-year rolling correlations.
[The above is by Hashmat Khan of Carleton University and Nyamekye Asare of the University of Ottawa.]