Rebranding the Canadian economy in the wake of the oil slump

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The Globe and Mail is hosting a debate on the economy among the leaders of the three main political parties on Thursday at 8 pm (ET). Click here for more details.

It's a single data point that neatly captures Canada's shifting economic fortunes.

Energy quietly dropped out of first place among the country's top merchandise exports in July, after a bump in auto sales knocked it off a perch it has occupied for eight consecutive years.

The petro-centric economy Canadians have known for much of the past decade is reversing course. And it may be years before oil regains the lofty heights of $100 (U.S.) a barrel.

This isn't just a story about exports, of course. Energy – and more specifically oil and gas – has powered Canada's economy, driving business investment, interprovincial migration and government policy. Oil and gas activity accounts for less than 10 per cent of the economy, but a much larger share of exports (25 per cent) and business spending (30 per cent).

With the federal election campaign now under way, political parties are highlighting efforts to boost much bigger, but neglected and still-fragile parts of the economy – the export-oriented service and manufacturing sectors. Canada will always be a big resource producer, but experts say the challenge for the next government will be to help ease the transition to a more balanced economy – one that is greener, more focused on services, and built on skills and brains, rather than crude and brawn.

The commodities supercycle was good for Canada in a lot of ways, including helping to give the West more economic and political might than it has ever enjoyed. But it also masked a host of chronic problems, including a significant loss of factory capacity, deteriorating export competitiveness, anemic productivity growth and a shaky record on innovation and business R&D.

It won't be easy or cheap to fix those problems, while also filling the hole left behind by a shrunken oil patch.

The cheaper dollar, a byproduct of lower commodity prices, will help a bit, but it's not a panacea, and it comes at a significant price. The cost to businesses of buying imported technology has jumped by roughly a third, and consumers are taking a hit to their purchasing power and standard of living.

Autos have regained their position as the country's leading export, for now. But the industry's glory days of the last century are gone forever as vehicle assembly and parts production gradually migrate to lower-cost locations, such as Mexico and the southern United States.

"We shouldn't expect any kind of rebound in manufacturing as a share of our economy, even with the dollar where it is," argued Glen Hodgson, chief economist at the Conference Board of Canada. "There is always going to be someone who can put a car together at a lower price."

Manufacturing now accounts for roughly 10 per cent of the economy, down sharply from 18 per cent in 2000. Employment in the sector has shrunk nearly a quarter. Much of it may gone forever.

The key for businesses and governments is to focus less on Canada's resources and manufactured goods, and more on the value we put into them, Mr. Hodgson said. That means services and high-value niches in global supply chains. A typical smartphone might be assembled in China, but most of its engineering and value comes from North America, Japan or South Korea.

"The new economy won't be built on resource extraction or manufacturing," Mr. Hodgson pointed out. "It will be built on brain power."

Many manufacturers are already adjusting to new economic realities. During the boom, General Electric Co. targeted the global oil and gas industry as a major growth opportunity for its various industrial-equipment operations. The company opened a customer innovation centre in Calgary three years ago, aiming to work with the then-thriving oil patch to address cost and environmental challenges.

As commodity prices fell over the past year, the industrial behemoth based in Fairfield, Conn. has had to pivot to other opportunities, GE Canada president Elyse Allan acknowledged in an interview. But it expects to find them, not in any particular sector, but at the intersection where manufacturing, services and innovation all meet.

While some of its traditional sales to the oil sands producers are slowing with the downturn, the Calgary innovation centre remains a busy hub.

"To drive performance optimization in a volatile market, customers will want – and we're seeing it in oil and gas – production optimization and performance optimization," Ms. Allan said. "And the way they will get that is by having those machines be as smart as they can be."

If the economy is to make a successful shift away from commodities, it will need help from efficient and export-oriented manufacturers, such as Guelph, Ont.-based auto parts maker Linamar Corp. As many parts manufacturers decamped to Mexico or the U.S. South, Linamar has seen dramatic growth at its Canadian operations, which make engine, transmission and other drive-train components, which are then exported to U.S. plants. The company has tripled its sales since the depths of the 2008-09 recession, increased productivity by 50 per cent, and added 4,000 employees to its Canadian work force. Linamar recently scored a $1-billion (Canadian) order that will help keep its Canadian operations humming.

CEO Linda Hasenfratz rejects as "ridiculous" the notion that Canadian manufacturers can't compete with low-wage jurisdictions.

"When I think about what makes a company competitive, I think about two things: innovation and efficiency," she said. "You have to be innovative in the products you are designing and the processes you design to make those products. And you have to improve that every single day. You also have to improve your efficiency every single day."

A pivot to fostering the new economy may not come easy for whichever party forms the next government. Oil and gas extraction has long dominated the government's agenda. Ottawa has invested enormous amounts of political capital trying to get pipelines built and removing regulatory hurdles facing the resource industry, while paying relatively scant attention to the challenge of creating a more balanced economy.

Canada has put too many of its eggs in one basket – energy – agreed Paul Boothe, a former top federal and provincial bureaucrat who now heads the University of Western Ontario's Lawrence National Centre for Policy and Management. "When the thing that we've been focusing on runs into difficulty, we're at a standstill."

There's no question that Conservatives zeroed in on Western Canada and its energy sector as economic and political priorities from the beginning of their tenure in power. The government, like its Progressive Conservative cousins in Alberta, provided a sympathetic ear to the oil industry, especially in its aims of expanding and diversifying markets through pipelines, such as the Keystone XL and Northern Gateway projects.

In the past year, however, the West and its energy sector were reacquainted with the biggest factor that influences the resource industry: the power of the market. Oil prices have been more than halved to below $50 (U.S.) a barrel over the past year, forcing the companies into emergency mode. The Canadian Association of Petroleum Producers (CAPP) has estimated capital spending in the industry will sink by at least a third to $46-billion (Canadian) this year. As many as 35,000 jobs have already been lost.

Billions of dollars' worth of oil sands and other energy developments that had been on the drawing board have been shelved or cancelled since oil prices crashed late last year, and the outlook remains bearish under a growing school of thought among analysts and executives called "lower for longer." Goldman Sachs on Friday said oil prices could fall as low as $20 (U.S.) a barrel given the global glut.

Despite its current woes, the resource industry is notoriously cyclical, so no one is writing it off as on its last legs. The question is, when it could rebound.

The industry is likely facing an extended period of lower prices for oil and gas, and slower exports to the U.S., creating a continuing drag on Canada's trade balance, said Judith Dwarkin, chief energy economist at ITG Investment Research in Calgary.

"There are structural forces at work that augur for a slowing pace of growth in exports of crude to the U.S. in particular, and continued slowing exports of natural gas to the U.S.," Ms. Dwarkin said.

Efforts to create markets beyond the United States for Canadian gas so far have faltered. Plans to develop a liquefied natural gas industry on the West Coast have been slow to come to fruition in the face of stiff competition from the United States, Australia and elsewhere.

CAPP, the energy sector's main lobby group, still sees an increase in energy production over the next 15 years, but its forecast has been tempered by the collapse in crude prices and high development costs by world standards. This year, it cut its outlook for oil output in 2030 by 1.1 million barrels a day to 5.3 million.

Politically, the new Alberta NDP government under Premier Rachel Notley has started to change perceptions about the province in the rest of the country, and with major trading partners in ways that could strengthen its position despite the downturn, said Gaétan Caron, executive fellow at the University of Calgary's School of Public Policy and former chairman of the National Energy Board.

"Alberta at this time is a nice place to envisage structural, strategic and systemic changes in the way we look at the future as a province – what the economy is made of, [and] the necessity to develop all forms of energy including renewables and non-renewables," Mr. Caron said.

But Ms. Notley's government so far has offered scant details on any plans to diversify the economy beyond a pledge to support refining and processing Alberta's bitumen.

In previous decades, the Alberta government poured taxpayer dollars into investments in an airline, meatpacking plant, and a cellular phone company, with little long-term gain to show for it.

Now, the chatter is about building on existing non-energy industries, such as agri-food or biomedical technology.

"Alberta needs to think of itself as more than an oil and gas economy," the University of Western Ontario's Mr. Boothe said.

The key for Alberta is to focus on reserves that are most economical to exploit, driving down costs, and diversifying its economic base.

"Maybe you don't do it by squeezing oil out of sand at Fort McMurray," suggested Mr. Hodgson of the Conference Board. "Maybe you do it by being good at all other aspects of the value chain in energy – from raising capital to energy management and finding new extractive technologies that produce less greenhouse gases."

The good news is that Canada's economy is resilient, and diversified. Other commodity-dependent countries, such as Norway and Australia, have been hit as hard, or worse.

As the commodity sector stumbles, there will be increased focus on other industries that can pick up the slack and help drive growth and jobs.

"It's about innovation; it's about services," said John Manley, head of the Council of Chief Executives, which represents the country's largest corporations.

There are vast opportunities in tradeable services – such as data management, telecommunications, financial services and consulting – as well as the production of goods, including manufacturing, agri-food and processing of raw resources, he said.

Mr. Manley – a former Liberal industry and finance minister – said future governments need to maintain and enhance Canada's competitiveness through the tax system and improved skills training. Infrastructure spending is critical so long as it is targeted at productive assets, such as transportation, telecommunications and energy links, versus hockey arenas and community centres.

But he said the country should not forsake efforts to boost resource development and access new markets, but it needs to do a better job limiting the environmental footprint of oil and gas development, especially in the much-maligned oil sands.

"Never underestimate the importance of the resource sector, even in a period of reduced commodity prices," Mr. Manley said. "History tells us we're in a cyclical downturn but things will turn up again. But the next time the world is thirsty for oil, we're going to have to have a better story to tell about how we're producing it."

Lower energy and commodity prices are providing some price breaks for households, but the depressed loonie offsets those by driving up the cost of imported foods and other goods. There is little room for debt-burdened consumers, the overbuilt housing sector, or governments to take up the slack. Governments at both federal and provincial levels are committed to fiscal responsibility, but even those espousing deficit spending are not proposing investments large enough to provide much stimulus.

Liberals, New Democrats and the Green Party are targeting the clean-tech sector as a promising source of growth. The global imperative to reduce greenhouse gas emissions is driving investment in energy efficiency and renewable energy, and in advanced technology that allows companies to reduce energy and water use and boost their productivity.

Canada is falling behind in the international clean-tech marketplace. While employment in the sector grew by 9,000 jobs to 50,000 between 2011 and 2013, Canada's global share of manufactured environmental goods fell over the past five years to 1.3 per cent from 2.2 per cent, said Celine Bak, a senior fellow with the Centre for International Governance Innovation in Waterloo, Ont. That represents $125-billion (Canadian) in lost revenue for the industry.

"The No. 1 barrier for clean technology companies is access to debt capital, and No. 2 is access to equity. So policies that will enable capital markets to form around the sector are going to have very high impact and leverage," Ms. Bak said.

Mississauga-based Hydrogenics Corp. is exporting hydrogen-based energy systems to global markets and has a work force of 75 people in Ontario and 200 worldwide. CEO Daryl Wilson said clean-tech firms would benefit from a strategic approach that combined financial backstopping and better co-operation between small companies, universities, governments and big corporations.

"The clean sector needs to be part of Canada's brand," he said.

A transition to a more a more balanced, greener knowledge-based economy won't happen overnight. And it will be costly – putting the onus on future governments to be smarter about their policy and investment choices.

But with a gaping hole in Canada's GDP left by the oil slump, doing nothing isn't an option.

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Economic promises from the parties

With the once-booming resource sector in retreat, Canada's three main parties are campaigning on their prescriptions to nurse an ailing economy back to health. Here are the top campaign promises, as provided by Conservative, New Democratic Party and Liberal officials.

Conservatives

Despite indications the economy fell into a shallow recession in the first half of the year, Leader Stephen Harper is maintaining a "stay the course" approach, focusing on low taxes, balanced budgets and selected tax breaks to help households.

Among the Conservatives' economic planks:

• Expand the Home Buyers’ Plan to allow first-time buyers to withdraw $35,000 from tax-free accounts for down payments, and establish a permanent Home Renovation Tax Credit, for renovation expenses totalling up to $5,000.
• Maintain current tax rates for individual Canadians, who were recently given a break by the Harper government with the introduction of the Universal Child Care Benefit and the Family Tax Cut – a measure that allows income-splitting between spouses and is particularly beneficial for high-income and lower-income couples.
• Focus on small business, by reducing red-tape by 20 per cent and harmonizing regulations with major trading partners.

New Democrats

Facing lingering doubts about the NDP's friendliness to business, Leader Tom Mulcair is promising to focus on small companies – which he says create 80 per cent of Canada's jobs – while making strategic public spending on infrastructure.

Among the NDP planks:

• Long-term, stable investments in infrastructure, transit and housing, including $3.7-billion annually for roads, bridges and other infrastructure; $1.3-billion for public transit, and support for 10,000 affordable housing units.
• Championing manufacturing, including auto, aerospace and green tech, through targeted tax credits. This week, Mr. Mulcair promised a plan to boost aerospace innovation and investment through a new fund aimed at small and medium-sized enterprises in the sector.
• Reduce the small-business tax rate to 9 per cent from 11 per cent, while raising the overall corporate tax rate.

Liberals

Leader Justin Trudeau says the election is all about protecting the economic well-being of the middle class, and suggests the economy will grow more quickly when households have more income to spend.

Among the Liberal planks:

• Commit to a 10-year, $60-billion spending plan to rebuild the country’s roads, bridges, water treatment plants, and other infrastructure.
• Increase taxes for the top 1 per cent of earners, and offer a tax cut to middle-class families.
• Implement a $300-million plan to support growth in clean-technology firms in specific sectors, such as mining, forestry, energy, agriculture, and environmental protection.