As the world ricocheted from financial crisis to Great Recession to multiyear malaise, Canada was rightly heralded as a rare bastion of economic tranquility. The country’s banking sector emerged largely unscathed, its housing market continued to charge higher and its economy suffered less and rebounded faster.
However, this glowing narrative is starting to lose its sheen. Most of the developed world now basks in reviving growth forecasts, while Canada finds itself bracing against seven ill winds.
The first problem is Canada’s new penchant for living beyond its means, as demonstrated by a large current account deficit equal to 3.3 per cent of gross domestic product. This vies for the worst reading in the developed world and the loftiest in 20 years, resurrecting bad memories of an era that ultimately saw Canada’s sovereign debt rating downgraded.
The second challenge is a lack of economic slack. Official estimates put Canada’s output gap at a modest minus 1.5 per cent. It is arguably much smaller, given a demographically adjusted unemployment rate of just 5.9 per cent and surveys that shows firms struggling to meet demand or secure workers. Thus, as other countries begin chomping through their enormous output gaps, Canada will find itself unable to keep pace, or risk inflation trying.
Number three is a correction in Canada’s housing market. Granted, the latest housing data are actually showing renewed vigour. But the root cause of this persistent buoyancy is not much of a mystery. Canadian borrowing costs have been quite cheap, paired with ready access to credit. On the global stage, only a handful of countries managed to deliver this pairing, and all experienced rousing housing booms.
An initial glance at the housing market reveals surprisingly little to get worked up about: Housing starts are only slightly elevated, housing affordability is normal and household credit growth is sluggish.
A closer examination, however, reveals two important qualifiers, both of which are on the cusp of relevancy. First, housing affordability is only fine because borrowing costs are historically low. As yields rise, this will start to bite. Second, housing starts data conceal the true problem. As anyone who has been to Toronto will tell you, the sky is black with cranes. The backlog of condominiums already under construction is unprecedented. No doubt builders will drag their heels to smooth the absorption of these units into the market, but this will come at the expense of materially fewer future projects.
Fourth (and related), household credit growth should remain sluggish. It has already shrunk by two-thirds from its peak, and may slip further given still elevated household debt levels and stubbornly rapid 18-per-cent annual growth in car loans.
Fifth, business investment – which the Bank of Canada expects to underpin future growth – may disappoint. Surveys of intended capital expenditures continue to blink yellow. This is hardly surprising given that Canadian corporate profits have fallen in five of the past seven quarters. More generally, upside is limited given that Canada’s capital investment share of GDP is already elevated relative to historic and international norms.
A disproportionate fraction of Canada’s existing investments are in the now-faltering commodity space. Resource firms across the globe are increasingly expressing regret at the largesse of their past investments as emerging-market growth wavers and commodity prices ebb. Many plan to temper their future outlays. Canada cannot expect to remain unaffected, particularly given the country’s high oil extraction costs and serious transportation constraints.
The sixth problem is Canada’s long-standing poor competitiveness. A rare silver lining of the global financial crisis was that it forced the worst-hit countries to press the reset button, repositioning them for growth. Inefficient firms and reckless banks were driven out of business, underproducing workers were shed and costs were trimmed. In contrast, Canada managed to skirt these tough decisions. Since 2000, the combination of a stronger currency and inferior productivity growth has elevated the effective cost of Canadian labour by a stark 53 per cent versus the U.S.
Seventh, it may feel even worse than it looks. Canada’s terms of trade are in retreat as commodity prices and the Canadian dollar fall. This isn’t captured by GDP, but it certainly hurts as Canada begins to receive fewer imports in exchange for its exports.
Of course, it isn’t all bad news for Canada. Exports look genuinely promising as the U.S. recovers, monetary policy remains stimulative and a falling currency provides a helpful boost. Moreover, the scope for serious trouble is limited precisely because Canada still retains some wiggle room in its monetary and fiscal policy.
The reality is rather more mundane: Other countries are now accelerating, while Canada – with seven jangling millstones around its neck – cannot. This reversal of fortune should leave Canadian growth underperforming both expectations and peers, for a change.
Eric Lascelles is chief economist at RBC Global Asset Management.
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