Monday, June 2, 2008

Macroeconomic keys to the evolution of Canada's economy


This summarizes a talk by Peter Hall, Chief Economist of Export Development Canada as part of the Canadian Leadership Orientation for North American MBA Students sponsored by ACSUS, HEC Montreal and the University of Ottawa Telfer School of Management.

The Canadian economy has evolved into one of the world’s most competitive. How has the structure of the economy evolved to place it in this position? Peter Hall, the Chief Economist for Expert Development Canada, focused his talk in four areas: inflation control and monetary policy, free trade, productivity and fiscal management.

Inflation Control and Monetary Policy

The context was that Canada was in a period of stagflation in the late 1970s and early 1980s. To control this, monetary policy was tightened. A protracted recession followed, but the medicine worked and inflation was controlled. Hall mentions that the adoption of these inflation targets was key to stabilizing the Canadian economy. There are some current debates about price targets or lowering the target inflation rate to 1%. Hall praises the leadership of the Bank of Canada in this area. Globally, Canada is looked to as a model in monetary policy.

Opening of surplus labor in China and creation of lower priced goods has been an important factor in controlling inflation globally. As that ends, countries and businesses need to consider how to keep prices under control. Another interesting point that Hall mentioned was that every $10 movement in oil prices moves to a 3 cent change in Canadian currency price.

Free Trade

In 1994, NAFTA was put into place. This was a major structural development that forms a key basis for Canada’s export Canada. International trade has always been a key component of Canada’s growth, even historically going back to the era of beaver fur trading. Prior to the free trade agreements, Canada’s trade to GDP ratio was 50%. Now it is closer to 70%. It actually peaked at around 85% during the high-tech boom. As the dollar has eroded, it has been very difficult to deal with the 8% to 9% currency valuation increase every year. Increased competitiveness and efficiency is essential in this type of environment. 85% of exports used to go to the US, now it is 79%. Share of trade with emerging markets has risen substantially.

Fiscal Management

In the early 1990s, the government was heavily saddled with debt and the country was closing in on 100% debt to GDP ratio. Hall points to this as a magic number where underwriters get very nervous. Canada moved to clean-up this fiscal policy and generate surpluses soon afterwards. Canada now produces substantial surpluses and has been paying down debt and in some cases lowering taxes. Debt to GDP ratio sat at around 28% at the end of 2007, a substantial improvement.

Productivity Growth

Canada’s productivity growth has been solid and steady, but not explosive at 2.5% to 2.8% in recent years. However, compared to the United States, it has been slower. America has been able to harness the rest of the world to make itself efficient. According to Hall, the US leverages of the comparative advantage and surplus labor, freeing up American workers to focus on higher paying jobs. Canada’s productivity growth is partially slowed by the integration and training of less skilled labor into the economy. This is especially the case in the industry, where marginal labor is being inserted to extract energy from lower grade sources, which weighs on the sources.
Other interesting points:

  • Hall believes that commodity prices are too high and that there’s a bubble coming. When the losses start to hit, the amount of investment assets erased to zero could be massive and be as big a catastrophe as the sub-prime crisis.
  • Hall perceives the venture capital industry in Canada as much more risk-averse. High tech companies go to the US because of venture. His company actually has equity group. He worries that about certain critical mass and then a bigger fish swallows them. He sees it as a scale issue.
Overall

Canada’s fate is intrinsically tied to the US and world economies as a major exporter. Hall’s view contradicts the view that markets are decoupling and perhaps more resilient. While there’s clear evidence of a slowdown affecting the rest of the industrialized world, it was surprising to some that a major recession didn’t kick in. However, in Canada, the slowdown is evident. Hall see Canada as a “canary in a coal mind”. He says “If the US catches a cold, we catch the flu.” However, Canada has a major economic stimulus package so consumers will feel some protection from the decline. However, exports are in a major slump. 9 out of 13 sectors are looking at major declines (many in double digits).

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