Thriving services sector masks broader economic recovery weakness

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Given the continued sputtering of Canada's economic recovery, you might be surprised to know that the biggest part of the economy – the services sector – has quietly been growing quite nicely. Indeed, no less authority than the country's central bank is zeroing in on services as a key engine for economic growth. But that may say more about the country's growth problems than it serves as a solution.

The Bank of Canada gave prominence to the services success story in its quarterly Monetary Policy Report (MPR) last week, with a full-page special subsection headlined "Canada's Service Sector Is Driving Economic Growth." The bank uses these subsections, known as boxes, to draw attention to elements of the economic outlook it considers particularly important in its assessment of monetary policy. The special treatment suggests services may have evolved into the next big hope in the bank's long search for a segment of the economy on which the recovery can hang its hat.

This is largely by default. Past economic engines either have seized up entirely (resources) or look headed for a stall (housing). The great hopes previously identified by the central bank to lead the recovery, non-resource goods exports and business investment, remain stuck in low gear. As the bank pointed out elsewhere in the MPR, the economy is headed for an annualized growth pace of just 1.5 per cent in the fourth quarter, and an even crummier 1.1 per cent for all of 2016. It forecast a modest improvement for 2017, to 2 per cent – a less-than-impressive figure that most private-sector economists nevertheless think is too optimistic.

Still, it's no small thing for the services sector to be thriving. As the MPR points out, services account for about 70 per cent of Canada's gross domestic product, and about 80 per cent of its jobs. And for whatever growth the Canadian economy has scraped out in the past year, services deserve all the credit.

The latest employment figures from Statistics Canada show that the services sector has added 186,000 jobs in the past 12 months, while the goods-producing sector has lost 42,000 jobs. Services GDP was up 2.4 per cent year-over-year in July (the latest data available), compared with a year-over-year contraction of 1.3 per cent in the goods sector. Services exports in the second quarter were up 3 per cent from a year earlier in real (inflation-adjusted) terms; goods exports were down 1.6 per cent.

But the need to lean so hard on an over-abundance of services growth, while surely welcome in the absence of much else, may actually help explain the frustrating lack of traction in the broader economic recovery. Specifically, two key elements the economy needs to deliver more sustainable growth – higher incomes and business investment – are being muted by the dominance of services.

The average pay for services-sector jobs is 25 per cent below that of goods-sector jobs. Even though wage growth in services has outpaced that of goods-sector wages, it's building from a lower starting point. The result has been overall tepid wage growth, which is contributing to the sluggish economic pace.

Meanwhile, growth in the services side of the economy doesn't translate as well into growth in business investment, simply because services businesses are typically much less capital-intensive than the goods sector. While services account for 70 per cent of Canada's GDP, they make up only a little more than half of business capital spending; before the bottom fell out of oil and gas investment, services made up only 40 per cent.

And while services exports are thriving, they remain tiny relative to goods exports, accounting for about 15 per cent of the country's export business. Their growth does not even come close to making up for the stagnant state of goods exports, which remain the crucial component of Canada's trade success.

None of which is to say that a flourishing services sector is not a good thing for Canada, especially at a time when little else is pulling its economic weight. Services exports, especially, provide Canada with ample space to grow, and should continue to flourish with the declines in the Canadian dollar. And Canada's services jobs are increasingly skewing to higher-paying professions, as engineering and technology increasingly supplant traditional manufacturing as the value-added products Canadians provide the world.

But if we're counting on a rotation of the Canadian economy toward services as the key economic driver this cycle, it's no wonder the broader improvement has been slow to materialize in many of the key traditional contributors to growth. Services have a long way to go before they can deliver the kind of wages, investment and exports that a healthy goods sector generates – and, unfortunately, those are the key elements this recovery sorely needs.