A SEISMIC SHIFT

This is the first instalment of a series on Canada's economy and its shift away from resources

Before there was a Canada, there were the resources.

The Europeans arrived in this harsh, untamed land more or less by mistake, looking for a shortcut to the Far East; but the abundance of natural wealth lured them back. The fish and furs and trees, the ores within the earth, the vast expanses of rich soil – the natural resources were the reason people came here, stayed, formed the communities and towns and cities that eventually banded into a country.

"The present Dominion emerged not in spite of geography but because of it," wrote economic historian Harold Innis in 1930 in The Fur Trade in Canada, perhaps the most influential examination of Canada's economic development ever written.

The land was, simply, Canada's greatest competitive advantage in the global economy. The more mechanization opened up that land, the bigger an advantage it became. The way that advantage has taken form evolved as the Canadian economy grew and matured through the breakneck technological revolution of the 20th century and into the 21st, but the increasingly rich and complex economic house we have built still has, at its foundations, our natural resources. If we had any doubts, the heady rise and painful fall of the Canadian energy sector, and the reverberations throughout the national economy, have put an exclamation mark on the point. Resources remain central to the country's economic dialogue.

And there's no question that Canada has greatly prospered from its resource wealth. But critics have argued for much of Canada's history that this "staples" economy, with its dependency on export markets, has skewed our economic policy-making, left us susceptible to foreign appetites, and impeded the development of a more robust, self-sustaining domestic economy. We have remained prone to booms and busts that periodically whipsaw our well-being and re-divide our nation between haves and have-nots.

This is Canada's "staples trap," as famed Canadian economist Mel Watkins coined it in his seminal 1963 paper "A Staple Theory of Economic Growth": The tendency for the country to tilt its economic resources and policies in support of one particularly in-demand staple or another that, inevitably, leaves the economy struggling when the staple falls out of global favour. Some modern economists would dismiss Mr. Watkins's staples theories as quaint historical artifacts in a Canadian economy that has grown more mature and complex over the past five decades. But our experience with our recent national love affair with oil – and its heartbreaking, economy-shaking end – raises some profound questions about our economic future.

"We bet the farm on oil prices staying high and rising, but that hasn't happened and, it would seem, is unlikely to in any near future," said Mr. Watkins, 84, in a recent interview via e-mail.

"We need to go back to the 1970s when there was genuine debate in Canada about industrial policy transcending staples. We opted for persistence, and signed free trade agreements that had that effect," Mr. Watkins said. "Increasingly, growth in Canada has been powered by bitumen. When that stalls, as it now has, the Canadian economy mopes along."

Canada enters its 150th year of nationhood facing a major economic restructuring, as it weans itself off its latest dependence on natural resources. Beyond that, some are asking whether this long and painful reconstruction doesn't present a timely opportunity – to once and for all break the 400-year dominance of resource exploitation and exportation.

With rising questions about the future growth of goods trade, the emergence of potentially massively disruptive technologies, and – perhaps most critically – increasing doubts about the long-term viability of non-renewable resource production in the face of climate change, the time may be ripe to set the country's economy off in a new direction.

But if resource exports have always been our natural comparative advantage and economic engine, then where does Canada go from here? What's the next stage of maturity for the economy – and are we prepared for it?

"Is Canada unable to grow at a satisfactory rate unless exports lead, or able to do so but relieved of the necessity until now by good luck?" Mr. Watkins asked in his famous paper. More than a half-century later, his question has taken on a new urgency.

The long drift away, and the backslide

If Harold Innis is considered the father of the staples theory, Mel Watkins is certainly its revered stepfather. His 1963 paper, both a description and a critique of Canada's resource-dependent economic development, formed the basis of economic and political debates at the core of this country's industrial policy for more than 50 years. Progressives on the left embraced his ideas as a call to arms for a more activist, even protectionist, approach to nurturing diversification of the country's industries away from the traditional resource base. Free-marketers on the right dismissed his theory as a description of a Canada of the past, which may have begun rooted in its resources but had naturally grown out of that early stage to become a modern, diversified industrial economy by the time Mr. Watkins published his famous paper.

There may be some truth to both.

Although natural resources have never strayed far from our national economic consciousness, it could be argued that their overall footprint on the Canadian economy was in long-term decline for decades. When Mr. Innis published The Fur Trade in Canada, in the early days of the Great Depression, agriculture accounted for one-third of the country's total employment. By the time Mr. Watkins wrote his famous follow-up to Mr. Innis's work, it was down to 10 per cent; today, it's less than 2 per cent. The mining business reached its peak, as a share of employment, in the mid-1950s.

For a while, the manufacturing sector surged to the fore. In the postwar boom of the 1950s, more than one-quarter of the country's workers were employed in factories. Some economists have argued that manufacturing was a natural extension of the staple economy, as the same conditions that made Canada a great exporter of things like wheat and wood – critically, abundant and fast-flowing waterways that powered grain and lumber mills and provided ready transportation systems – proved perfect for generating the electricity for factories and the routes to transport their output, while the resource base delivered the raw materials for a new value-added export economy.

"By 1999, the five high-value-added sectors (automotive, aerospace and other transportation equipment, machinery, electronics, and consumer products) together accounted for almost 60 per cent of Canada's goods exports, while the primary sectors (agriculture, energy, mining and forestry) accounted for just one-quarter," wrote Jim Stanford, perhaps the country's best-known labour economist, in a recent paper published by the Institute for Research on Public Policy. "Canada had largely escaped its legacy as a supplier of unprocessed 'staples' to the rest of the world."

But by the turn of the 21st century, manufacturing's share of employment had fallen to 15 per cent; today, it's less than 10 per cent. And this wasn't the result of increased automation; manufacturing's share of gross domestic product also declined, from nearly one-quarter in the early 1960s to about 11 per cent now.

The country's goods-producing economy has been gradually supplanted by the rise of services – a wide range of economic activities from retail to financial services to education and health and government. Fifty years ago, services made up about 55 per cent of Canada's gross domestic product; today, they account for 70 per cent.

Despite the decline in the relative size of resource-based goods in the economy, a series of factors in the past quarter-century or so converged to reassert natural resources as the cornerstone of Canada's economic growth. In the wake of the Canada-U.S. and North American free trade deals of the late 1980s and early 1990s, trade surged as a percentage of GDP – and the vast bulk of the gains came from resources.

A broader wave of global trade liberalization at the same time added to the momentum. As trade barriers fell, emerging markets such as China rapidly expanded in global trade, capitalizing on their low costs for manufacturing export goods. While this put pressure on higher-cost manufacturers in Canada and elsewhere, it also accelerated China's rapid growth and urbanization – which drove booming demand for raw materials from the likes of Canada. Increased global competition caused nations to gravitate to their comparative advantages – and Canada's embarrassing wealth of natural resources rose to the surface once again.

Exports of metal ores and minerals have more than doubled, by volume, since the 21st century began; energy export volumes have increased more than 55 per cent. Those two resource sectors alone accounted for nearly two-thirds of Canada's real growth in goods exports in the past 15 years. (By contrast, export volumes in the auto sector have fallen 11 per cent in that time.) The mining and oil and gas extraction sector, which makes up about 8 per cent of Canada's GDP, accounted for nearly 20 per cent of nominal GDP growth in the decade prior to the 2008-2009 recession.

"The global commodities boom shifted capital and policy attention toward extractive industries," Mr. Stanford said. "Canada's economy has been moving down, rather than up, the economic value chain."

Booms and busts

Oil's makeover of Canada's economy

History may look back on the oil boom era as a spectacular but brief detour in Canada's economic evolution away from its resource dependence. But that detour diverted an enormous amount of money and human resources into the energy sector – and that has resulted in significant change in Canada's economic structure.

In the five years between the recession and the collapse of global oil prices, the oil and gas extraction business accounted for two-thirds of Canada's capital spending growth. With the sector, the country's capital spending increased 38 per cent from 2010 to 2014; without it, growth was just 18 per cent. By 2014, oil and gas extraction made up more than one-quarter of the country's capital spending.

But oil's collapse has put a dramatic end to that investment trend. The Bank of Canada projects that capital spending in the energy sector this year will be down 60 per cent from two years ago. As the country's economic activity rotates gradually away from the now-depressed energy sector and toward other healthier areas of the economy, investment money will increasingly resurface in other sectors where opportunities lie – but it's going to be a slow process. The central bank said in its most recent Monetary Policy Report, in April, that this "complex adjustment" will take "several years" to unfold, suggesting that it will have "important consequences for the growth of potential output" until at least 2019.

In addition to all the investment money that flooded into the energy sector, there was also a massive flow of human capital – workers from all corners of the country who rushed to high-paying jobs in producing regions.

Over the past 20 years, the net interprovincial migration to Alberta (people moving there from other provinces minus people leaving Alberta for other provinces) totalled nearly a half-million; the only other province in that time with a net inflow from other provinces was British Columbia, with about 100,000. The eight other provinces, combined, suffered net interprovincial outflows of nearly 600,000. The resource boom, driven as it was by surging demand from Asia in general and China in particular, tilted the flow of workers dramatically toward the western end of the country. Overall population growth in Alberta and British Columbia since 1995 has been 36 per cent – twice the rate of the rest of the country.

More than a year into the commodity downturn, there is evidence that this flow of humanity has begun to reverse: In each of the past two quarters, more people moved out of Alberta than moved in – the first time that has happened, outside of a national recession, in more than two decades. But as long as the re-allocation of investment capital will take, the reversal of provincial labour migration should take much longer; people and families don't relocate anywhere nearly as quickly as money. Even in the face of the oil shock, more people still moved into Alberta from other provinces last year than moved out.

Still, the Canadian economy outside of the resource sector is holding up rather well in the face of oil's collapse. The Bank of Canada noted in a January report that in roughly the first year of the oil shock (November, 2014, to late 2015), there was a striking divergence between the pummelled economies in oil-producing provinces (unemployment rate up 2.5 percentage points, housing starts down 33 per cent, retail sales down 4.3 per cent) and the rest of the country (unemployment rate unchanged, housing starts down 3 per cent, retail sales up 2.7 per cent).

This may be evidence that Canada's broader economy isn't as beholden to its staple exports as it once was – or, at least, that oil doesn't have that same grip on the country that dominant resources of the past had.

"Oil as a staple stacks up poorly in generating widespread growth within Canada compared to, say, the fisheries or wheat," Mr. Watkins argued. "Bitumen has not been a national east-west staple. Its linkages are much more north-south in terms of both inputs to production and of distribution by pipelines." As a result, he said, "The bust of the oil economy has not wreaked destruction on the rest of the economy."

But what has emerged from the oil era is a problematic rift in the modern Canadian economy between the resource and non-resource sectors. The economy, both during the oil boom and after the bust, has looked really more like two economies determined to go in opposite directions.

"Our careening back toward resource extraction in the past 10 or 15 years has gotten us to the point where we're neither here nor there," said Dimitry Anastakis, professor of Canadian economic history at Trent University in Peterborough, Ont. "We've gone from hewers of wood and drawers of water, to a more industrialized economy, to now this kind of a seesaw back and forth."

Vancouver's False Creek, then and now

Click or swipe to see the area's transformation over 40 years. (Skip ahead to read more.)

Supercycle at an end, trade at crossroads

It looks unlikely that in the future, Canada will be able to take the same resource-paved roads to prosperity that brought the economy to where it is today. The global commodity supercycle, which fuelled record prices for Canadian resources, may well be over.

The notion of a supercycle is that every once in a while, a large and lengthy expansion and urbanization of a global economic power fuels a sustained boom in demand for natural resources that can last for decades. The world went through one such supercycle around the end of the 19th century and the early years of the 20th, reflecting the emergence of the United States as an industrial power. It went through another in the decades after the Second World War, amid the reconstruction of Europe and the rise of the Japanese economy. And it went through one for much of the past two decades, with China's explosive modernization.

But now China's economic expansion has not only slowed, but is being steered into a new phase by the Communist country's economic planners. The country is transitioning from its stage of rapid urban, industrial build-up to a more mature, stable, slower-growth economy that will rely more on self-sustained consumer demand and less on the kind of massive transformations that fed the supercycle.

As China's once-insatiable appetite for raw materials fades, commodities appear to have shifted onto the long downside of the supercycle. Commodity prices may be doomed to a long, sideways drift at relatively tame levels that could last for decades.

For the oil and gas business, the long-term prospects look even more grim. The growing global momentum for green energy looks poised to steadily erode demand for fossil fuels over the coming decades. We may one day look back on the oil-price collapse of 2014-2015 as the beginning of the end for the industry.

"With climate change, the fat is now truly in the fire," Mr. Watkins said.

It might also be just the kick in the pants Canada needs to start setting its economy on a new, less energy-export-dependent growth path, he suggested. "The case for transformative policy is now utterly compelling."

But after years leaning our investment capital, labour and even our political policy toward natural-resource exports, it may take a serious overhaul, not just in our economic structure but in our national way of thinking, to change course away from oil and other export commodities and align with a global economy that is struggling to recreate itself after the global financial crisis and Great Recession.

The post-financial-crisis era has raised questions about the future of goods exports. After years of strong growth thanks to the worldwide trend toward trade liberalization, global growth in goods export volumes since the financial crisis has been persistently far below historical norms, and well below growth in global gross domestic product. The trade of goods has been shrinking as a component of the world's economic activity.

"Globalization fuelled an irrational exuberance that lasted five to seven years. We've spent the past seven years working that off," said Peter Hall, chief economist at Export Development Canada.

He argues that the Great Recession, with its resulting protracted blow on demand in many foreign markets, prompted the Canadian economy to spend years looking "inward" – to rely on low domestic interest rates to fuel made-at-home investment and consumer growth. "That's tapped out. We've gotten about as much as we can get out of it," he said.

But now, he believes, the economy is on the cusp of a shift outward – to "turn our focus back to the export sector." He said manufacturing capacity that had turned its focus to serving domestic demands – including those of the energy sector – can now be redeployed to serve export markets as they continue to recover and move into expansion mode.

"We're at a turning point," he argued. "I don't believe we're in a new normal."

But it's notable that Canada's goods exports stalled even before the financial crisis. Over the past 15 years, volumes have grown by an average of less than 1 per cent a year – despite the commodity boom and the signing of nearly a dozen free trade agreements during that time. Some experts have suggested that traditional trade deals to lower tariffs and improve access to foreign markets may have gone about as far as they can go in terms of expanding demand for Canada's goods. And as the recent Brexit vote in Britain and the presidential campaign in the United States have vividly demonstrated, there is a rising mood of economic isolationism that raises questions about the direction of future trade negotiations.

"At the very least, we should be open to the possibility that FTAs are not a magic bullet for Canada's trade ailments," Mr. Stanford wrote in his paper.

And indeed, the nature of the global economy may be on the cusp of a dramatic change that will make the past norms of global commerce look quaint. Transformative technologies that are only now beginning to emerge – things like fintech and artificial intelligence – promise profound and highly unpredictable changes to the global economic landscape in the coming decades.

"People are just not getting the disruptions that are coming in the economy," said Dan Trefler, professor of economics at the University of Toronto. "It's like being on a railroad crossing and a train is about to slam into us."

The innovation agenda

The future, many experts say, may be based more on our country's base in knowledge than in natural resources.

Exports of services have grown at nearly double the pace of goods over the past 15 years. For much of the world's history, services have, by their very nature, been restricted to their domestic economies. But thanks to leaps in digital technology and global connectivity, many high-value services – things like financial services, engineering and architecture, accounting and management, data analysis and software development – have become not only exportable, but instantly so.

"Globalization and digitization has changed everything," Mr. Anastakis said.

A high-profile example of this sort of shift came in June, when General Motors of Canada unveiled plans to hire up to 750 new employees at its massive Oshawa, Ont., facilities – not production-line workers building cars, but rather engineers who will research and design the high-tech, digitally integrated vehicles of the future.

On hand for that announcement was Prime Minister Justin Trudeau, whose new government has pledged to make innovation the cornerstone of its economic growth plan. The government outlined its innovation agenda, albeit only in very general terms, in an announcement two weeks ago, following up on Mr. Trudeau's pledge on the global stage at the Davos economic summit in January to rebrand Canada as a global hub for technology and advanced skills.

"My predecessor [Stephen Harper] wanted you to know Canada for its resources. I want you to know Canadians for our resourcefulness," Mr. Trudeau said, thus coining a new mantra for Canada's future economic aspirations.

Many of those involved in commodities production are, understandably, not nearly so willing to consign the resource story to our national past. Nevertheless, there is clear potential to tap into our expertise and skill sets in the increasingly high-tech and data-driven business of resource exploitation, to open new markets and new areas of business. Oil-pipeline giant Enbridge, for example, is making an aggressive shift toward renewable energy technologies, investing more than $1-billion in the past seven months on wind-energy projects. Alberta's recent budget earmarked $3.4-billion over the next five years to fund "large scale renewable energy, bioenergy and technology" in an effort to diversify its huge energy industry.

The pursuit of a national innovation strategy is widely applauded by economic experts, and most agree that it's something for which Canada is, at least in theory, well-suited. The country has many qualities that are generally believed to foster innovation: A highly educated and culturally diverse population, and relatively good income equality and economic mobility among its citizens. The country also has a highly sophisticated, stable and reliable financial sector to help grease the funding wheels for innovation.

But Canada has a long way to go. The Conference Board of Canada ranks our country only ninth out of 16 peer nations in innovation, citing in particular Canada's lacklustre public and private spending on research and development. On the Global Innovation Index, released annually by Cornell University, the INSEAD business school and the World Intellectual Property Organization (a UN agency), Canada ranks a modest 14th out of 34 OECD countries.

Critics charge that our economic focus on resource exploration and exportation during the commodity boom has proven incompatible with an innovation agenda – something that will have to change.

"If we are to take advantage of the transformational opportunities that progressive technology enables, we need to invest in the skills acquisition that will drive that," said entrepreneur Bryan de Lottinville. His rapidly growing Calgary-based Benevity Inc., which provides software-driven services managing corporate charitable-giving programs, has been struggling to find enough people with the right skill sets to fill its needs in Calgary's resource-centric work force. He argues that the entire country has put too little focus and funding into high-tech education and skills development.

"We have to invest meaningfully in a long-term approach to this stuff if we want to diversify our economy. It's not something that we can only do while the price of oil is low."

Cynics point out that policy makers have been talking about innovation and diversification for as long as economists have been talking about the staples theory, yet the resource habit has proven hard to break. Even with the motivation of a deep and potentially prolonged slump in global resources, and particularly the oil and gas sector, it will take a lot of collective will – from government, from corporate Canada and from the public – for the economy to step out of its staples comfort zone.

"It's certainly easier," Mr. Trefler said. "Ripping stuff out of the ground doesn't require the same entrepreneurism, ingenuity and innovation as coming up with the next BlackBerry."

The transformation of False Creek

The evolution of Canada's economy in recent decades is visible in many urban landscapes in Canada – but perhaps nowhere more dramatically than at False Creek, the narrow waterway that cuts along the southern shoreline of downtown Vancouver and leads into the heart of the city.

In Vancouver's development as a major industrial centre and port in the late 19th and early 20th centuries, False Creek – home today to some of the most prized real estate in the country – was a key locale for the region's booming lumber industry. Its shores, near the western terminus for the CPR trans-Canada railway, were teeming with sawmills, rail lines, warehouses, factories and ship-builders that still dominated the landscape into the 1970s. As former Vancouver mayor and current provincial member of the legislature Sam Sullivan noted in a blog post on the history of the area, a mayoral candidate in 1950 decried False Creek as "nothing more than a filthy ditch," vowing to fill it in to create more land if elected.

But today, that "filthy ditch" would be nearly unrecognizable to the people of a couple of generations ago. Its mills and factories have been replaced by marinas, restaurants and the city's current booming industry: Condos. The former factories of Granville Island, on False Creek's south side, were long ago converted to a thriving public market. The rail yards and docks have been replaced by park lands and seawall recreational paths serving fitness-conscious urban dwellers. The nearby Yaletown warehouse district is now a trendy hub for designers and tech startups.