Where will Canada's growth come from?

The consensus outlook for Canadian economic growth in 2012 is generally tepid, with the possibility of another international financial crisis tipping us into recession as it did in the fall of 2008.

After looking over the potential sources of growth, it's easy to see where this consensus came from. One of those data-intensive posts with lots of graphs is below the fold. I don't necessarily have a profound insight, but I think it's useful to look through the numbers in order to get a better idea of where we are and how we got here.

As noted in the never-to-be-linked-to-often-enough beer and pizza post, there are two ways of increasing national income: making more stuff (i.e., increasing GDP) or getting better prices for the stuff we're already making (i.e., an increase in our terms of trade)

This is the latest version of a graph I've produced several times, based on data in Cansim Table 380-0062: 

I don't think it can be stressed enough that a surprisingly large share of the not-insignificant growth in incomes that we saw in the last decade was due to a favourable shift in Canada's terms of trade.

Here is a table that the good people of Industry Canada once put together for me, using more data and expressed in terms of per capita income:

More than half of the increase in per-capita national income between 2000-2007 was due to an improvement in our terms of trade.

Here is how the terms of trade have contributed to the recovery of Gross Domestic Income during the recovery: 

Few will be surprised to learn that that to a very great extent, fluctuations in our terms of trade are due to fluctuations in commodity prices. Here is an updated version of my graph of Canada's terms of trade and the Bank of Canada's commodity price index:

So what can we expect from our terms of trade? I don't know. Oil prices may go up if China continues to grow and/or if the encouraging recent US numbers hold up. If not, not.

Next up is GDP. Here is how the various components of GDP have contributed to output growth through the recession and recovery: 

The sharp drop in the value of the Canadian dollar provided a boost to net exports that provided a cushion during the recession, but as was the case in the last expansion, they have generally been a drag on growth during the recovery. The driving force behind GDP growth was at first consumer and government spending, and then investment.

One thing I noted at the time but never got around to blogging about is how odd the last two sets of GDP numbers looked. GDP fell In the second quarter, but the behaviour of its components - strong investment, weak net exports - made it more representative of an expansion. The reverse happened in the third quarter: relatively strong GDP growth, but since it was done mainly by net exports and without investment, it looked more like a recession than an expansion.

Let's look at how these factors break out. Here are the components of consumption expendutures:

Expenditures on durable goods are most cyclical, and they explain much of the fall and recovery in consumption expenditures. But I was surprised to see how sensitive services were to the cycle.

Looking into 2012, it's hard to see how or why consumption expenditures would play a larger-than-ordinary role in GDP growth. Given the concerns about household debt, another surge in durable goods expenditures is unlikely, even if interest rates stay low.

Statistics Canada's national accounts tables break out government spending according to spending on goods and services, investment and changes in inventories. That last term is negligible, so here is how the other two components contribute to government spending: 

 

The stimulus program shows up in the investment series, and the timing here is interesting: the arrival of significant government investment in 2009Q3 coincided with the recovery in GDP. I wouldn't want to use this as an illustration of the effectiveness of the stimulus package one way or another (we need the counterfactual), but it's worth noting.

But again, now that the recovery is a couple of years old and governments are looking at deficit reduction, government spending isn't likely to be an important source of GDP growth in 2012.

As seen above, the fall in GDP during the recession was largely due to the sharp reduction in investment spending:

 

In the early stages of the recovery, investment spending was concentrated in residential construction, and then in machinery and equipment. Non-residential construction doesn't seem to have contributed much during the recovery.

This is one sector where there is some hope and expectation that growth might be sustained. Low interest rates and a Canadian dollar that is still around parity with the US should make for a cost of capital that is still quite low, so the question will be if firms see enough in the way of expected future profit opportunities to justify new investment expendutures.

 

 

The net exports component enters aggregate demand in an unfortunate way, reinforcing the seemingly-innate mercantilist tendency to interpret trade surpluses as a good thing. But since Canadian net exports are generally countercyclical, an increase in net exports is better seen as a sign of weakness in the Canadian economy, not of strength.

In the good-news scenario, the prices of oil and other commodity prices stay high, the Canadian dollar will stay around parity and net exports will be a drag on growth. In the bad-news scenario, commodity prices fall, the Canadian dollar depreciates, and net exports will rise.

And that's where we are.

Comments

[JP Koning]

Nice charts, very informative. I agree with you that investment could be the main driver of growth going forward. Canadian corporations are unlevered relative to consumers, and Canadian manufacturers have gotten quite lean over the last few years, maybe they will help drive things.

"Looking into 2012, it's hard to see how or why consumption expenditures would play a larger-than-ordinary role in GDP growth. Given the concerns about household debt, another surge in durable goods expenditures is unlikely, even if interest rates stay low."

We've definitely been seeing a lot of weakness the last two or three quarters in the retail sector. TMX-listed stocks like Le Chateau, Reitmans, Rona, and Indigo have had a brutal time. While these are not durables, they are sensitive to credit-card deleveraging.

http://www.pollitt.com/upfile/pdf/Aug_2011_Wrap.pdf

Statistics Canada also breaks GDP up by industry. Would be interesting to see you have a go at that.

[Angelo Melino]

Another very nice post. But you could have just as easily called it "Where will Canada's (output) growth go"? A similar presentation and discussion of the components from the table you cite provided by Statistics Canada might be a better match for your title...and would make another interesting post!

[Jacques René Giguère]

Thanks for showing that "barbarian" budget policy can still make a contribution to GDP stabilisation...

[Stephen Gordon]

Oh, I wouldn't go that far. As I said, we'd need a counterfactual scenario for what would have happened in the absence of the stimulus package.

[Jacques René Giguère]

Stephen: We are grown-ups. From many declarations from Flaherty and others, we may infer a lot. With a majority in fall 2008, Harper would have sent us to European hell. That's my belief and I believe it. It might even be true...

[Stephen Gordon]

Yes, it would take a certain amount of convincing before I'd believe that things would have been no different if the original Harper govt instinct to impose austerity at the beginning of a recession had become policy. But it's still a possibility that I'm not yet ready to rule out.

[AMS]

From a much less rigorous standpoint the fact that investment was forgone in the "recent" past due to trepidation concerning economic events leads us to expect that at least some of that investment will have be made at a later date.

However, this does presuppose that confidence returns.

More significantly, from a Canadian standpoint, our economic growth will be driven by whether or not our major trading partners grow. Let's not give our internal activities a higher level of import than they deserve.

So, to reposition, investment in the US was likely have lagged and could certainly provide a "stimulus" of its own if confidence returns to the US and international markets.

Flip a coin.