the canadian economy: recession, recovery and transformation

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The Canadian Economy:Recession, Recovery and

Transformation

APEGGAApril 23, 2009

Glen Hodgson Senior Vice-President & Chief Economist

[email protected]


Three Themes for Today

• The economic outlook in exceptional times

• The financial crisis

• Transformation: what will the world look like after recovery?



Global Economic Highlights

• The world economy will contract by 1 per cent in 2009, even with policy intervention

• The U.S. financial crisis and recession has rippled around the world

• Sustained but slower growth in emerging markets, led by China and India, is barely blunting the impact of a U.S. slowdown



U.S. Outlook

• U.S. economy is in deep recession

• Consumer spending to fall for 5 quarters as confidence collapses

• Heavy government intervention to address the financial crisis and provide stimulus

• Some faint glimmers of good news beginning to emerge



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4.5

5.0

5.5

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6.5

7.0

7.5

8.0

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150

160

170

180

190

200

210

220

230Sales avg. price

U.S. Existing Home Sales and Prices (millions SAAR; $’000)

Source: National Assn. of Realtors.


-700

-600

-500

-400

-300

-200

-100

0

100

200

U.S. Labour Market(Change in U.S. Employment, 000s)

Source: Bureau of Economic Analysis.


U.S. Consumer Confidence – Lowest in History(1985=100)

Source: The Conference Board Inc.

20

30

40

50

60

70

80

90

100

110

120


U.S. Real Consumer Spending Growth(per cent change, annualized)

Sources: BEA; CBoC

-8.0-7.0-6.0-5.0-4.0-3.0-2.0-1.00.01.02.03.04.05.0


US Federal Deficit(Unified, $billions)

Sources: BEA; Moody’s Economy.com

-1900-1700-1500-1300-1100

-900-700-500-300-100100300500

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010


-3

-2

-1

0

1

2

3

4

5

'96 '97 '98 '99 '00 '01 '02 '03 '04 '05 '06 '07 '08 '09 '10

U.S. Real GDP(per cent change)

Sources: BEA; CBoC.


Canadian Outlook

• Canada dragged down by global recession and sharp drop in commodity prices

• Fiscal stimulus packages in Canada and the United States will eventually pull us out of recession

• Employment will decline throughout 2009 and the unemployment rate will peak at just below 9.5 per cent in mid 2010

• A recovery is in store for 2010, with real GDP growth rebounding to 2.5 per cent


Raw Materials Price Index (per cent change)

Sources: The Conference Board of Canada; Statistics Canada


Real Exports (per cent change, 2000–10)

Sources: The Conference Board of Canada; Statistics Canada.

-12.0

-8.0

-4.0

0.0

4.0

8.0

00 01 02 03 04 05 06 07 08 09 10


0

1

2

3

4

5

6

7

8

99 0 1 2 3 4 5 6 7 8 09f 10f 11f

Sources: The Conference Board of Canada; BEA; Statistics Canada.

Canada

Interest Rates (90-Day T-Bill) Quarterly 1999–11

U.S.


60

64

68

72

76

80

84

88

92

96

100

104

Exchange Rate 2000–10U.S. cents per Canadian dollar



Index of Consumer Confidence, CanadaJan 2003–Mar 09 (2002 =100)

65

70

75

80

85

90

95

100

105

Source: The Conference Board of Canada.


Employment Growth Canada, 2000–10


340,000 job losses


5

6

7

8

9

10

11

12

13

1981 83 85 87 89 91 93 95 97 99 01 03 05 07 09 11 13Sources: The Conference Board of Canada; Statistics Canada.

Unemployment Rate

Natural rate

Unemployment Rate vs. Natural Rate (percent), 1981-2013


Real Consumer Spending Growth Canada 2001–10


0

1

2

3

4

5

2001 2002 2003 2004 2005 2006 2007 08f 09f 10f


Housing Starts vs. Demographic Requirements Canada 2001–10 (000s)

Sources: The Conference Board of Canada; Canada Mortgage and Housing Corporation.

140

160

180

200

220

240

1 2 3 4 5 6 7 08f 09f 10f

Household formation


Pre–Tax Corporate Profits(per cent share of net domestic income)


18 per cent in 2008Q3


Real Business Investment Growth (Canada 2001–10)



-40

-30

-20

-10

0

10

20

Federal Provinces

Federal and Regional BalancesNational Accounts Basis ($ billions)

Sources: Statistics Canada; The Conference Board of Canada.


Real Government Spending on Goods and Services Canada (per cent change, 2000–10)


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Real GDP Growth Rate Canada 2001–09



Conclusions

• Some signs that key U.S. markets are nearing bottom—a modest recovery in residential construction and auto sales is forecast for the second half of 2009

• Strengthening raw material prices in 2010 will provide a boost to domestic economy

• Recession will lift unemployment rate but labour markets will remain tight across many occupations

• Path back to balanced budget will be slow for the federal government while provincial governments are in a more difficult bind


The Financial Crisis: A Perfect Storm

Two underlying conditions:1. Global savings – investment imbalances

– Massive global savings available – Asia and oil

– Supported by accommodative U.S. monetary policy

2. Unconstrained financial market innovation and leveraging– Insufficient financial market regulation at all levels

– New financial instruments (securitization, credit swaps)

– Global distribution networks

• www.conferenceboard.ca


Worst-Hit U.S. Housing Markets (price declines Dec. 2008/Dec. 2006, %)

• Phoenix -44• Las Vegas -43 • Miami -41

• San Francisco -39

• Sacramento -36

• Los Angeles -36

• Tampa Bay -32

• Detroit -32

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Global Action, Sept–Oct 2008

• U.S. government intervention to save two investment banks – but not Lehman Brothers

• Nationalization of key U.S. institutions (Fannie and Freddie, AIG)

• $700 B funding obtained from Congress, of which $250 B in government equity invested in banks

• Coordinated intervention by EU governments – equity injections, guarantee inter-bank credit lines



Credit Spreads Have Stabilized(3-month Libor minus 3-month US T-bills)

Source: Moody’s Economy Inc.

0.00

0.40

0.80

1.20

1.60

2.00

2.40

2.80

3.20

3.60

4.00

4.40

4.80

'sep2 'sep17 'oct1 'oct16 'oct30 'nov13 'nov 28 'dec12 'dec30 'jan14 'jan29 'feb12 'feb26 'mar12


So Where Are We, Six Months On?

• Financial markets not back to normal anywhere

• Central banks forced to slash rates and even introduce quantitative easing to kick-start their economies

• Governments are purchasing and guaranteeing loan assets to inject liquidity and free up bank capital



Aggressive Global Monetary Policy

Central banks around the world have taken aggressive action

• U.S. and Japan; rates almost at zero• Bank of England has cut short rates to lowest level

ever – since 1694!• Many have introduced quantitative easing (QE) --

money creation via bond purchases• ECB is finally cutting rates on the continent



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2002 2003 2004 2005 2006 2007 2008 2009

U.S. Japan UK Euro Zone

Short-term Interest Rates (per cent)

Source: Consensus Economics.


Spread between High Yield Debt and 10-Year Treasury Notes

Inc.

600

800

1000

1200

1400

1600

1800

2000

2200

aug sep oct nov dec 'jan09 feb


Federal Reserve Balance Sheet(total assets, $billions)

Source: FRB.

600800

10001200140016001800200022002400


Renewed U.S. Action: The Geithner Plan

• Create a $1 trillion public-private market for illiquid mortgage-backed securities, rather than a “bad bank”

• Stress testing of banks to ensure they can withstand a prolonger recession

• U.S. Treasury to supplement credit program with up to $1 trillion in new government credit

• $175 billion mortgage refinancing plan: – $100 billion more to backstop Freddie and Fannie– Individual incentives to refinance mortgages – how

to separate “can’t pay” from “won’t pay” ?



Equity or Nationalization?

• Saving the financial system: more equity and guarantees, or nationalization?

– Government ownership of Citigroup to rise to 36 per cent of common stock

– But government is very reluctant to fully nationalize key institutions – even AIG

– Major banks begin shift to black – W-F, B of A, Citi

• $175 billion mortgage refinancing plan:– $100 billion more to help Freddie and Fannie

– Incentives to refinance mortgages – how to separate “can’t pay” from “won’t pay” ?



The Fed’s Latest Bold Moves

March 18, the Fed threw everything it has at the financial crisis:•QE: $300 billion to purchase long-maturity Treasuries, driving down long rates by 50 bps•Doubling, to $1.45 trillion, the securities purchased from Fannie Mae and Freddie Mac•$1 trillion to buy private securities and rebuild credit markets



And Room for Even More

• Obama budget for 09–10 includes another $250 billion on-budget for re-starting credit

• Price tag so far: $10 trillion and rising

• And the bottom is not yet reached—more to come through ‘09



Action in Europe• U.K. government prepared to use taxpayer

money to ensure that banks survive prolonged recession

• Iceland was forced to nationalize its major banks last year following collapse

• German banks hold $1 trillion euros in risky assets and have only written down 25 per cent

• More trouble on horizon, since banks in Western Europe hold 90 per cent of East European debt



Canadian Action

Canada doing much better than other countries, but we too are feeling the pain

•Federal government offer to purchase up to $125 billion in CMHC-insured mortgages from banks•ABCP market freeze has been resolved –after a year •$350 million capital to BDC and EDC, with increased leverage



Direct Government Intervention (cont.) • Canadian Secured Credit Facility—Fed govt.

will purchase up to $12 billion in asset-backed securities

• Assurance Facilities: Fed govt. ready to insure borrowing by banks and insurers to reduce any competitive disadvantage

• Bank of Canada accepting much riskier collateral



Canadian Access to Credit

• Total bank lending to business up by 11.5 per cent in Jan ‘09 over previous year

• But commercial paper market still shrinking • Risk spreads up by about 2 per cent • Banks rebuilding balance sheets and loss provisions• Canadian banking system still profitable; Q4 2008

bank profits down but positive• Non-banks and foreign banks retreating from Cdn.

market, Cdn. banks buying key assets (e.g. car loans)



Mortgages and Other Credit Markets

• Annual mortgage lending up 10.7 per cent (Dec 2008)

• Last 2 decreases in bank rate matched by decreases in mortgage rates

– freeing up purchasing power and improving affordability

• But senior loan officers continue to report tightening in lending conditions

• Consumer credit remains under pressure



U.S Financial Crisis: Our Assessment

• U.S. government will stabilize the financial system —regardless the huge cost

• Outright nationalization a last resort, to be avoided if at all possible

• This means continuing equity and guarantee support for key banks—while others will fail

• Fed has jumped in with both feet• Mortgage refinancing plan will help to form a

bottom for the housing market– But subject to further adjustment and cash injections



Global Financial Crisis: Our Assessment

• Governments at different stages of response

• U.K. government seems ready to ensure its banks will survive prolonged recession

• Some other governments still in earlier stages of reacting – e.g. Germany

• The big scare: Eastern European debt

• Canadian financial system looks remarkably well-positioned , although it will take all of 2009 to rebuild more normal credit.



Transformation: Where Are We Going Next?

• Recessions are usually a catalyst for transformation

• So what will be different when the economy recovers?

• We expect macro forces to be at work as well as structural changes within industries



Big Global Drivers

• Shifting economic tectonic plates: the rise of China, India and other emerging nations

• Global value chains and “integrative trade”

• Energy and climate change

• Aging labour force in the industrialized world



The World Economy: Slower Growth Potential

• Americans to save more and spend less

• World economy needs a new growth driver since American consumer retrenching

• But consumers in Asia-Pacific won’t pick up all the slack —cultural reasons, need to save due to lack of safety net

• Therefore, global economy to experience sub-par medium-term growth (2.5% per year)



Fiscal Policy, Give and Take

• Short-term fiscal stimulus is critical to recovery and will boost output in 2010 and 2011

• But fiscal stimulus will be withdrawn as governments grapple with deficits and debt burden

• Fiscal consolidation means slower MT growth



What About Globalization?

• Globalization process similar to period around World War I

• Increased trade protection, despite promises from politicians

• Fewer bilateral trade deals• Tension: Need for investment, but pressure for

controls on FDI due to fears of sovereign wealth funds



Aging Among the G-7 • Most G-7 countries are aging rapidly and facing

much slower economic growth

• Japan, Italy and Germany at ZPG

• Despite higher birth rates and immigration, U.S. growth potential will ease to 2.5 per cent in 2020

• U.S. still has advantage of more flexible economy, younger and growing population

• But: twin deficits are a major medium-term risk



Canada to 2030

• Aging population will drive changes in the economy

• Supply constraints on labour already here

• Immigrants will be the sole source of population growth by 2030

• Potential output weakens through 2030

• Capital spending the strongest source of growth

• Productivity gains would help sustain GDP



Energy

• Renewed upward pressure on oil and gas prices as global demand returns and supply gets tighter

• Greening of energy production is here to stay

• Race to find alternative energy sources will mean strong diversification within the industry

• Industry rationalization on the rise again – as well as expanded role for emerging market players



Resource Processing

• Products that new markets demand, rather than trying to convince them to buy what we make

• High value-added niches, not commodities -- compete on quality, design and service– E.g. derive more value from forest resources by

making energy substitutes rather than pulp and lumber

• Transitioning workforces and regional economies to new and/or growing products and services



Life Sciences

• Demographic pressures mean shift from disease treatment to maintenance and prevention

• Long-term and chronic care will increasingly take precedence over acute care

• Diseases in developing countries will grow in importance

• Emerging markets will demand access to drugs at low prices via forced licensing or even ignoring patent protections

• Growing financing requirements for R&D etc



Automotive

• Fewer players -- Detroit 3 becomes the Detroit 2 or even Detroit 1, and Japan will go off-shore

• Changed product offerings -- fewer light trucks, more fuel efficient vehicles, decline of internal combustion engine

• New selling model -- fewer dealerships, leasing changes, on-demand supply

• Lower cost structure – wages, pressure on suppliers

• Designers and marketers, or builders?



Aerospace

• Higher energy costs drive demand for ever more fuel efficient airframes and engines

• Materials science produces lighter weight materials and innovations in vehicle design

• Military seeking more off-the-shelf components and solutions rather than design from scratch

• New air travel demand from middle class in developing markets

• New infrastructure for air travel -- air traffic control, regional airports, noise, GHGs



Conclusions

• We are about half-way through the current financial mess and recession

• The Canadian recovery is not here yet – but it’s on the horizon

• The world will not be the same as we emerge into recovery

• So be ready to dance on your toes!



Highlights: Canada to 2030

• Aging population will drive changes in the economy

• Supply constraints on labour already here

• Immigrants will be the sole source of population growth by 2030

• Potential output weakens through 2030

• Capital spending the strongest source of growth

• Productivity gains would help sustain GDP



Population of Those Aged 65 and Over(per cent; share of total population)

Sources: United Nations; Statistics Canada.


Population Growth is Waning

• Aging boomers and weak fertility rates will reduce number of births

• Deaths will increase as the numbers entering older cohorts continues to grow

• Natural rate of increase will slow dramatically over the forecast horizon



Population Distribution by Age, 2007



Source Population Growth(per cent change, compound annual growth)



Population Distribution by Age, 2030



Labor Force Participation Rate (per cent, 1985-2030)



Labour Force Growth(per cent change, compound annual growth)

Sources: The Conference Board of Canada;


Changing Composition of Production

• Much weaker growth in the labour force, and in employment, means that organizations will have to change their “capital-labour ratio”

• They will need to replace labour with capital (i.e. technology) to keep operating

• This will put strong upward pressure on wages, and require workers with deeper skills who can adapt quickly



Machinery and Equipment Investment Growth

(per cent change, compound annual growth)



Private M&E Investment (share of total GDP)



Non-Farm Private Labour Productivity(per cent change, compound annual growth)



Real GDP Canada (per cent change, compound annual growth)



Replenishing the Workforce

• There are essentially three inter-related options for adapting to aging demographics:

• Invest in education: increase the skills of the workforce

• Raise levels of immigration, and speed up integration

• Encourage older workers to work longer



Invest in Education and Skills • Canada’s education system gets an “A” in The Conference

Board’s report card on Canada, “How Canada Performs”

• But this high overall grade masks low basic skills and literacy for over 7 million Canadians

• We also under-perform at the high end – investing in educational excellence

• And education funding is being crowded out by public health care spending



Expenditures on Public Education as a Share of GDP(per cent)

Source: OECD.


Sources: The Conference Board of Canada; OECD.

Adult Literacy Proficiency—Proportion with Low-Level Skills

(per cent)


Invest in Education and Skills: Priorities • Make education funding a higher priority

• Improve education levels and skills – Increase innovation in our education system – Expand international experience and language

skills – Address the skilled trades gaps – Enhance aboriginal and immigrant education

• Embrace lifelong learning– Address basic literacy and numeracy skills



Productivity: A Conceptual Policy Framework

Skills/Human Capital

Innovation

Investment

National Operating Environment including Infrastructure

International Trade & Investment

North American Integration


Conclusion

• Future domestic labour supply will be more scarce

• Investment in education and skills is critical

• Immigrants build workforce capacity

• Attracting and keeping older workers is a critical source of talent



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