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Looking at the US GDP numbers released today, and judging by their apparent insistence on repeating the Japanese experience with zombie banks, Canada might be forced to figure out how to get out of the recession on it's own.

Intuitively, between diversification of our trading partners and increasing domestic AD ought to be able to do it, after all we're only 31 million people and it's a big world. We also have one really big advantage over just about everyone else in the world: our financial intermediaries aren't walking dead (not yet anyway).

Enough debt... leave the fiscal policy at home, please. We can survive a few years of recession, the world won't end.

I think this is a brilliant question.

One sort of answer might involve frictions, so adjustments may happen slowly, with persistent costs, and to some extent adjustments might not happen at all. Another potential answer has to do with the what levels of productivity are available in different sectors, so that it might not be possible to reallocate resources and achieve the same level of productivity.

is it possible for Canada to recover from the recession, even if the rest of the world does not?

Yes it is possible, but here's why it won't happen.

Despite 2008 being another record breaking year for corporate profits (280 billion), Canada's corporations are set to reduce capital investment by $25 billion this year and are looking to cut costs by laying people off. The private sector is clearly going to protect its profit margins instead of pulling its weight to help get us out of this recession.

The Harper stimulus budget is not a stimulus budget. We need real investment in infrastructure but instead Harper is giving us bleepin' granite countertops. Harper's budget is an ideological one designed to prove that government's can't stimulate the economy. In other words, it's designed to fail.

We don't have enough aggregate supply to even meet an increase in aggregate demand. Look at the trade numbers. We still mostly export our raw resources and import finished goods. We can't consume our own goods when there are none to buy.

Yep. More autarky please.

Luis Enrique's comment adds something I had forgotten: "Another potential answer has to do with the what levels of productivity are available in different sectors, so that it might not be possible to reallocate resources and achieve the same level of productivity."

That would create an additional reason for the LRAS curve to shift left.

Maybe not. The adjustment we've been undergoing since 2002 is a trade-induced shift away from manufacturing. Shifting back (or halting the shift away) wouldn't be very costly.

Canada would have to have a free trade agreement with a complementary economy, such as Japan, but only they were also following a sufficiently expansionary monetary and/or fiscal policy.

USA Canada and Australia could each probably endure the cessation of global trading while maintaining basic social services under Martial Law. It would come with crippling rationing and GDP contraction. It is more expensive to make South Korea computers and Chinese textiles here.
I used to like a strategy of diversifying to APEC trade bloc but with evidence of resilient developing world growth we'd probably be best to seek trade growth with India (still barely positive GDP growth) and other developing world actors. Demand for S.Korean and Japan computers tanks in USA recession which maybe makes China a less than ideal hedge.

I keep telling friends who are feeling down and out that Canada is really well situated to ride this out:

- we have functional banks
- we have been running a double surplus
- we have a fairly well balanced economy. although the resource sector is an issue, we have pretty solid manufacturing, high tech, arts & media, medicine etc. etc.
- we have a large amount of natural resources, land, food, clean water etc. if American survivalists were really smart, they would be trying to get Canadian citizenship
- we have a stable political system
- we have relatively good social equality
- we have a good reputation around the world in both business and government, and good trade relations
- although America is currently the source of a lot of the problems, they are still a great neighbor to have, and generally a good trading partner (all softwood aside)

There are some big challenges however. In terms of stimulus raising AD and employment, I see a problem of leakage to countries that have pegged currencies or currencies that are distorted by proximity to a pegged nation. As Stephen noted above:

"The adjustment we've been undergoing since 2002 is a trade-induced shift away from manufacturing. Shifting back (or halting the shift away) wouldn't be very costly."

It's true that we only recently shifted away from manufacturing, but the current system of global trade continues to induce that shift. With China struggling, they will probably keep their currency low, and workers there will accept even lower wages. I see the forces that are shifting manufacturing out of Canada getting stronger right now, not weaker. I think that this is a big problem. Canada has lots of natural resources and idle manufacturing capacity. It makes no sense for us to be exporting so much raw materials and importing finished goods (what are we, a british colony? har har). We want more value-added exports and domestic production for Canada, but the current system of global trade (wildly distorted labour costs, trade partners that subsidize heavily) makes it damn near impossible to do so.

an earlier commenter remarked: "It is more expensive to make South Korea computers and Chinese textiles here." but that is true only because of skewed labour costs in asia, massive subsidies etc etc.. In real terms there is nothing more efficient about shipping a bunch of Canadian-mined minerals over to China, having someone there assemble a ram chip out of it, even though we have all the equipment and know-how here to do so, and then ship it back as a finished product. It's massively inefficient, and is only profitable because of huge distortions in the global economy that encourage inefficient production methods. The current system creates PERSISTENT arbitrage opportunities, and rewards arbitrageurs rather than the most efficient producers. german factories are for more efficient in real terms than chinese factories. same goes for Canadian factories. it's just the skewed labour costs, subsidized materials and undervalued currency that makes asian products cheaper. If it were really only a matter of labor arbitrage in the traditional sense, arbitrageurs should have the effect of eliminating the inefficiency that they exploit by rapidly raising living standards in China and elsewhere, but they don't. The problem is structural.

If stimulus money ultimately gets spent at walmart and other importers, I can't see how value-added goods made in Canada will be able to compete. Any stimulus that we provide would be tiny on a world scale, and would be quickly swallowed up by the deflationary black-hole that is China.

"If the Chinese don’t cooperate, a portion of any US stimulus is lost to higher imports – always remember that the US doesn't’t have much excess productive capacity in tradable goods. The excess capacity exists in China. And Congress would be less than happy to see US tax dollars supporting Chinese jobs."--Tim Duy

Canada can't really recover alone without disengaging from world trade, but at the same time I don't really want to do that. So I guess my answer to the original question is no. Without going protectionist and perhaps causing worse long-term harm to our economy, we cannot recover from this alone. We will probably do as well as possible, but I don't see any way that any country in the world can really recover without a Bretton Woods 3 that fixes the massive structural problems in global trade.

If things get really really bad we could shut our borders to imports and stimulate like mad, and we would probably do OK, but that's really a last resort for a situation where global trade is in such shambles that there is no longer any real benefit in participating (if it is just inundating us with exported deflation from other larger economies). Saving global trade from collapse and working towards a shared recovery should be the first order of business, disengaging in order to recover on our own should be a last resort. On our own we could have a recovery of sorts, but the resulting standard of living would be a lot lower than if we were part of a shared recovery that maintains global trade.

so to clarify a little more, in response to Nick's original question:

We can deal with the drop in exports, but I think that the persistent flood of cheap imports would be a problem for domestic employment.

I think this is what Krugman meant when he said that for certain countries there is a prima facie case for protectionism. This probably applies more to the case of Canada than any other country in the world. In the long term though, free trade is better, for the same reasons that it is always better.

I view the combination of protectionism and aggressive stimulus to be a kind of Pandora's Box, if you will. I don't think there's any denying that it works, but it is dangerous. Aggressive Keynesian policies (before they were called Keynesian), protectionism and subsequently "Military" Keynesianism brought Germany out of recession before anyone else in the 30s, and made them extremely powerful. The problem with this approach is that there is an inherent danger of fascism/corpratism and it erodes global politics by making a lot of enemies. Economic nationalism can have the same bad effects as nationalism in general.
but it works:

"At first, Schacht continued the economic policies introduced by the government of Kurt von Schleicher in 1932 to combat the effects of the Great Depression. These policies were mostly Keynesian, relying on large public works programs supported by deficit spending — such as the construction of the Autobahn — to stimulate the economy and reduce unemployment. There was major reduction in unemployment over the following years, while price controls prevented the recurrence of inflation. The economic policies of the Third Reich were in the beginning the brainchildren of Schacht, who assumed office as president of the central bank under Hitler in 1933, and became finance minister in the following year[3]. Schacht was one of the few finance ministers to take advantage of the freedom provided by the end of the gold standard to keep interest rates low and government budget deficits high, with massive public works funded by large budget deficits[3]. The consequence was an extremely rapid decline in unemployment—the most rapid decline in unemployment in any country during the Great Depression[3]. Eventually this Keynesian economic policy was supplemented by the boost to demand provided by rearmament and swelling military spending

...

World prices for raw materials (which constituted the bulk of German imports) were on the rise. At the same time, world prices for manufactured goods (Germany's chief exports) were falling. The result was that Germany found it increasingly difficult to maintain a balance of payments. A large trade deficit seemed almost inevitable. But Hitler found this prospect unacceptable. Thus Germany, following Italy's lead, began to move away from partially free trade in the direction of economic self-sufficiency.[28]
Unlike Italy, however, Germany did not strive to achieve full autarky. Hitler was aware of the fact that Germany lacked reserves of raw materials, and full autarky was therefore impossible. Thus he chose a different approach. The Nazi government tried to limit the number of its trade partners, and, when possible, only trade with countries within the German sphere of influence. A number of bilateral trade agreements were signed between Germany and other European countries (mostly countries located in Southern and South-Eastern Europe) during the 1930s. The German government strongly encouraged trade with these countries but strongly discouraged trade with any others" (wikipedia)

Canada has lots of natural resources and a small population, so we would actually be able to do what Germany couldn't. theoretically we could close the borders to anything besides strategic imports, build a whole bunch of public works, keep interest rates low and do quite well. I can't really see Canadians going fascist, as we are almost like anti-nationalists. And hey, maybe we should look out for our own interests as a country for once? Everyone else does it. It is tempting in a way, but it would burn a lot of bridges with other countries, bridges that took a long time to build, and are good to have in the long run.

My current thought, especially after reading bob's comments, is that the answer depends on the theory of exchange rates. If, as we approached the Canadian LRAS (while other countries were away from their LRASs) the exchange rate appreciated, so that in the limit ALL the extra demand from Canadian monetary and fiscal policies caused a one-for-one decline in net exports, Canada would be unable to get out of the recession by itself.

But I can't (offhand) think of any theory of exchange rate determination which would give that result.

hmm... not sure if I'm understanding this correctly.

At the limit, I still don't think there would be a one-for-one deterioration of the trade balance. We would still get some stimulus (even if a consumer takes their stimulus tax rebate directly to walmart and spends it all on a Chinese appliance, the walmart employee, Canadian truck drivers etc. still get paid). The problem is that when a portion keeps going over to China and is saved, it reduces the multiplier effect of the stimulus spent. We get less bang for our stimulus buck, and soon the nominal amount of stimulus bucks would start piling up pretty high in the form of a massive national debt. Theoretically, we could stimulate our economy right back to full employment, but the result would be a crippling national debt, if the multiplier is low. That's the danger of leakage to a huge pegged nation that is determined to save and doesn't undertake its own stimulus.

is there a theory of exchange rates that takes into account a country that doesn't respond to traditional signals to stop saving, but simply continues regardless?

I'm not against stimulus though. Any stimulus just has to be designed to minimize leakage and maximize domestic employment, not just short run demand that could be soaked up by imports. I don't like tax rebates at all, for this reason. It's better to target employment directly rather than relying on a multiplier effect of unknown value. At least then you know that a fair bit of employment will be generated, and a useful public good will be built. We need make-work projects that employ a lot of people, build something that we actually need (In case that the multiplier ends up being poor, at least we would have something to show for it). Windsor-Quebec City bullet train, new subway lines in toronto, home renovation subsidies that are linked to bringing up the building code and making our homes more efficient, not just installing granite counter tops, expansion of the James Bay project, more nuclear stations, deep sea ports, research grants etc. etc.

An idea I would like to see formulated in economic terms is to increase the rate of ecological interaction within a domestic or local economy in order to increase local multipliers. So we don't have buy Canadian provisions, but buy local (and, for the anti-protectionists) sell local. This could be accomplished with various local scrips... how else?

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