Philip Cross, in the Financial Post, dives into the shocking rise in Canada’s gross domestic product (GDP) to start 2016.
By Philip Cross, April 6, 2017
Sometimes the saying that “if you aren’t confused, you’re not paying attention” seems to have been coined specifically for Canada’s economy. More than usual, even the best analysts are confused about what is happening. The January report for GDP shocked economists with a 0.6 per cent monthly advance, building on its momentum late in 2016. However, some commentators cautioned the news was overshadowed by President Trump’s executive orders the same day that called for an investigation of the practices of its trading partners, including Canada. In fact, the threats to our exports to the U.S. help explain why our economy is suddenly outperforming expectations.
First, some background on the U.S. economy. While the soft indicators related to consumer and investor sentiment picked up in response to Trump’s election amid much talk about deregulation and tax cuts, it is not clear how business-friendly his policies will be. While less government interference in the domestic economy clearly would be welcome, increased government regulation and barriers to the flow of people and goods entering the U.S. would be a setback for many firms. Even domestic policy in areas such as health care costs are steeped in uncertainty. Manufacturing is one exception with a marked post-election improvement in sentiment after months of treading water under Obama.
Meanwhile, the hard data on actual spending and production in the U.S. continues to sputter. Industrial production was flat in February, and is up only 0.3 per cent in the past year despite a post-election upturn in manufacturing and a weather-induced boost to construction. Auto sales, a key market for Canadian producers, softened in the first quarter. Real GDP growth is on track for less than a one per cent annual rate in the first quarter. None of this augurs strong growth in Canada.
So why is GDP in Canada surging recently? Most of the increase was driven by exporters in mining and manufacturing.
In Canada, the reverse pattern is evident; the soft data about business sentiment remains weak, but the hard data on output is surging. The stock market has slowed recently, as have commodity prices, while the dollar hovers around 75 cents U.S. These are hardly harbingers of a booming economy. Foreign firms are abandoning the oilsands, reducing the capacity for any major new investments. Overall, business investment plans for 2017 remain negative for a fourth straight year, especially manufacturing which depends on exports to the U.S.
So why is GDP in Canada surging recently? Most of the increase was driven by exporters in mining and manufacturing. Virtually every manufacturing industry has boosted production over the past three months, in contrast with sporadic gains in U.S. industrial output. It is easy to understand why firms are anxious to ship their product to the U.S. while the weather was mild, even if it just sits in inventory, given the risk exports might be slapped with a sizeable border adjustment tax in the near future. This is most evident in the auto industry, where the U.S. stock-to-sales ratio is at its highest level in a quarter of a century outside of the 2009 recession. Overall, exports to the U.S. have risen 5.1 per cent since October.
Once exporters start shipping more to the U.S., automatically there are ripple effects downstream for services such as wholesale trade and transportation companies, both of which made large contributions to the recent gains in GDP. Altogether, mining and manufacturing and trade-related services accounted for nearly 90 per cent of January’s hike in GDP, as domestic services and construction just spun their wheels. It is also telling that these same export-related industries added few new jobs in recent months, leaving the public sector to drive employment growth.
Of course, there is the possibility that higher manufacturing activity in Canada represents the long-awaited stimulus from a lower dollar, whose absence mystified the Bank of Canada throughout 2016, aided by improving manufacturing spirits in the U.S. after Trump’s election. This happy face interpretation does not stand up to closer scrutiny. If manufacturers finally were taking advantage of an improved competitive position in the U.S. market, then why would they be so pessimistic about investing in Canada? Manufacturers plan to cut investment by five per cent in 2017, after a 15 per cent cut in 2016. If manufacturers thought their recent output gains were sustainable, why are they so reluctant to commit to hiring more employees? Factory employment has fallen slightly over the last three months.
It seems more likely that the recent upturn in Canada’s GDP partly reflects the passing of the worst effects of the recession in Alberta’s oilpatch, allowing annual growth to return to its familiar post-crisis baseline of two per cent. But the additional boost to a six per cent annual growth rate over the last three months seems driven by a temporary burst of shipments to the U.S. before any possible trade barriers are erected.
All of this is summarized by the Macdonald-Laurier Institute’s leading indicator. After a brief pick up reflecting the burst of exports at the turn of the year, it slowed to 0.4 per cent growth in February, the same as before the unexpected blip in growth. Ultimately, we won’t know until after U.S. trade policy is clarified whether the upturn in exports is sustainable or not. Until then, the prudent interpretation is that while the “Trump bump” to growth initially has been stronger in Canada than in the U.S., fear of trade barriers is not a welcome source of growth.
Philip Cross is a Munk Senior Fellow at the Macdonald-Laurier Institute.