Ex post and ex ante comparisons of the Canadian and US employment recessions

Today's LFS release was another piece of welcome news: some 38% of the losses in employment and in hours worked have been recovered. And I think it's time for those who predicted that Canada was not going to implode to take a bow.

Way back in December 2008, I wrote a post with the title "Why are forecasters predicting a mild recession for Canada?"

But how and why can it be that anyone can think that Canada can escape with only a minor slowdown when pretty much everyone is predicting impending doom for the US?

To answer this, I'm going to do a quick, back-of-the envelope calculation, and then I'm going to do some moderately sophisticated econometrics. It turns out that both approaches yield almost identical responses.

The quick version first. Here's the story people tell when they explain why Canada will be affected by a US recession:

• Canada exports a lot of what it produces.
• The US is by far the biggest market for Canadian exports.

Both assertions are true: about 36% of Canadian output is exported, and about 77% of exports go to the US. So about 28% of what is produced here is shipped to the US. That's quite a lot, but it's hard to see how this would work as a mechanism for transmitting a severe recession. If (for the sake of argument) demand for Canadian exports is proportional to US income, then a Canadian recession would be about 30% as deep as the US recession that generated it.

US employment peaked in November 2007, four months after the subprime crisis started. Here is how employment levels in Canada and the US have evolved since then:

Gotta say that I'm feeling pretty good about that post. Employment losses in Canada turned out to be consistent with those back-of-the-envelope predictions.

I wonder if those who were confidently predicting Impending Doom are revisiting their predictions with a critical eye and are learning from their mistakes. I'm not optimistic - it's not clear they even remember what they were saying back then.

Comments

[Declan]

Reviewing your previous post, I expressed concern that your model didn't include the effects of commodity prices or the housing market. Since both have turned sharply upwards since the previous post, we haven't really settled much on that front yet.

With respect to the housing market, I admit that I didn't see coming the sudden upward reversal that occurred in 2009 (did anyone?). In retrospect, I feel that I underestimated the impact that lower interest rates would have on the housing market. Of course, with rates at the minimum now, that insight doesn't provide much predictive power going forward (aside from concern for how hard the market might be hit if rates ever go back up). Higher commodity prices may be sustainable (although the bubble in China is a bit worrying on that front) but I don't see how the upward trajectory of housing prices and mortgage debt can be.

With the rest of the world devaluing their currencies (when was the last time the CAD-GBP exchange rate was this high?) I'd add a third concern on the export front, although this will likely take a little time (a few years) to materialize.

[Patrick]

Makes me wonder how much of Canada's good fortune is simply due to the fact that our little corner of the financial system didn't explode. The transmission mechanism for monetary policy continued to function for us. Also, I wonder to what extent the so-called liquidity trap is really just an effect of the break down of banking and finance? Are there examples of countries falling into the trap without a financial crisis?

[Stephen Gordon]

I think that sounds right. I think it was John Cochrane who noted that there's no way that the size of the losses in the housing bubble could have caused the crisis - the losses from the dot-com bubble were much greater. The key thing was the fragility of financial markets.

That's sort of why I get so impatient with the claim that a fall in Canadian housing prices will generate a US-style crash here as well. The linkages aren't the same.

[Christopher Hylarides]

Patrick: I think liquidity trap pretty much equals a type of financial crisis. I'm also skeptical of liquidity traps in the Keynesian definition. A seize up in liquidity pretty much means that for some reason people aren't buying/selling an asset at an agreed price, so something is preventing the movement of price upwards or downwards. There's never been a liquidity trap in the stock market where somebody hasn't tried to put in a type of price control, for example. In the recent ABCP or bonds and other types of exotic securities (mortgages), people expected them to not go down in value at all, and held out expecting a bailout or insurance payment from firms like AIG. The result was a frozen market.

Stephen: I agree with you so long as people can still afford the mortgage payments. In Canada, people can't just walk away from their mortgages without declaring full out bankruptcy so the banks will be fine so long as people still get paycheques.

[duncan cameron]

This is interesting material. What happens when you plot public sector employment in both countries? And private sector employment? The latest LFS shows job losses in the private sector, and gains in the public sector. Restrictions on public sector employment are on the horizon in all Canadian jurisdictions.
Non-military public employment as a percent of all employment would be higher in Canada than in the U.S. (but lower than in Europe) I suspect but do not know for sure. The U.S. private sector was harder hit than the Canadian private sector, and if it is bigger in employment terms than the Canadian (as a percentage of the total) this might explain some of the large gap shown above.

[Mickey D]

I've witness the housing crash in the US first hand here in California. People in my gated development bought new homes 5 years ago in the $600-700,000 range and within a year or two had remortgaged them for over $1 million and made off with the cash. About 15% of the homes in the 130 home development have been foreclosed in the past year and resold for half the amount owing. Another 10% are either now foreclosed or in the process according to a monitoring service I subscribe to. Yes, people were using their homes as cash machines.

The impact of this on the economy cannot be overstated. These free spending people who bought a new car every 3 years, the latest big screen tv, lavish vacations, RV's, etc. have dried up and as an economy dependent on consumer spending the results are obvious.

So where will economic growth in the US come from? The cash machines are not open for business again. The tumbling US dollar will help exports but the US in percentage terms is not among the biggest exporters.

I think US employment numbers will just keep muddling along with little to no growth in the coming year or two. Canada can leverage its commodities to the larger world. Ontario will continue to be in a hard place, I think, with only a moderate growth of the auto sector.

[Skye Nott]

Commodities will keep us floating, but when the RE bubble pops I think we're going to find out a lot of people are leveraged to the hilt. Look at the personal debt numbers, they are through the roof. I don't think we're out of the woods yet.