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Trade worries cloud economic outlook

How to grow ‘Brand Canada’

Against a backdrop of global trade turmoil and a high dependence on external investment, Canada is facing a slower economic “speed limit” that is constraining growth.

Key insights

  • Global political uncertainty and rising protectionist policies are moderating global investment, and dampening growth prospects in Canada and abroad
  • While the Canadian labour market is strong, wage growth is tracking inflation, and rising rates mean an increasing share of the consumer’s wallet goes to servicing debt
  • The biggest hurdle for the Canadian economy is the prospect of a continuing inward-looking policy orientation and protectionism on the part of Canada’s largest trading partners, namely the US and China

According to Craig Wright, Senior Vice-President and Chief Economist at RBC, “If you look around the globe, the reason for a rise in global economic uncertainty isn’t difficult to pinpoint. The number one and number two global economies, the United States (US) and China, are fighting it out on the trade front. As a result, economic policy uncertainty is running at record highs.”

During his address at RBC Investor & Treasury Services’ (RBC I&TS) recent Investor Forum1, Wright further noted that, “When firms don’t have a clear line of sight on the future direction of the economy, the prospects for investment fall.”

Political uncertainty imposes limits to growth

Since the beginning of 2019, global forecasters around the world, including the International Monetary Fund, have moderated their growth forecasts.

These tempered expectations are the result of multiple factors converging, commented Wright. “As economies mature and monetary policy moves interest rates up, growth slows down and capacity constraints emerge which can limit economic growth,” said Wright. An economy’s speed limit, he added, is the product of its labour force growth and productivity. When one or both is inhibited, the rate of growth typically falls in response.

At the same time, when global political uncertainty is elevated, global investment falls. The state of global political/policy unease can be measured by the Monthly Global Economic Policy Uncertainty Index, an innovative index that monitors newspaper coverage of policy-related economic uncertainty.2 Compared to 2018, the index has risen significantly in 2019.

Longer-term structural issues in the Canadian economy remain unresolved, with real wage growth elusive

In an environment of global trade uncertainty, the Canadian labour market is strong. Recent statistics show 36,000 jobs added per month over the last year while the unemployment rate hit 5.7 percent in April.3 Real wage growth, however, remains elusive, with wage growth tracking slightly above inflation.

An economy’s
speed limit is the
product of its labour
force growth and
productivity.

While Canadian debt-to-income levels remain high, Wright notes that the most important variable in tracking the long-term health of Canadian households is the unemployment rate, as the proportion of mortgages in arrears is highly correlated to this measure. “As long as unemployment remains relatively low and stable, the risk of mortgage defaults will remain low,” he said.

Rising rates stretch consumer capacity to stimulate growth

With rising interest rates in recent years, the debt-service ratio, which is the proportion of household disposable income required to meet debt obligations, has increased. The impact of the debt-service ratio is a function of the run-up in consumer debt by Canadian households in recent years. Coupled with high consumer debt, rising rates mean that debt servicing costs “absorb more and more of the consumer’s pocket with those dollars unavailable for paying down debt or other spending,” commented Wright.

The most important
variable in tracking
the long-term health
of Canadian households
is the unemployment rate

Canadian consumer spending has slowed in recent months, meaning that in order for economic growth to continue, other factors must contribute. Currently, two of those key factors, exports and foreign direct investment, are significantly challenged. Canada’s main trading partner remains the US at 75 percent of exports, with China a distant second at around eight percent. Exports, in particular, are impacted by trade negotiations, including the as-yet-unratified US-Mexico-Canada Agreement (USMCA), which renegotiates the terms of the North American Free Trade Agreement (NAFTA).

Both the Bank of Canada and the US Federal Reserve are keeping rates “steady where they are,” with inflation tracking at or below target rates of two percent in both countries, and “no urgent pressure” for central banks to intervene in the foreseeable future, says Wright.

A challenging global environment puts the brakes on global investment

With the US Federal Reserve and the Bank of Canada putting future interest rate increases “on pause,” Canadian exports have received a lift, but concerns remain.

Competitive pressures include a shifting regulatory environment in Canada, compared to trade partners including the US. “In the last few years, the US has cut back on tax regulation, while Canada has gone the other way, adding more,” commented Wright. “This move has reduced our relative competitiveness, and to turn this around, we need to improve ‘Brand Canada’.”

The biggest hurdle for the Canadian economy is the threat of continuing protectionist policies

Looking forward, the biggest hurdle Wright sees for the Canadian economy is the threat of continuing protectionist policies. For Canada, which has a smaller open economy that is characterized by and very dependent on trade, the concern is that the US and China are each going their own way, with the risk that Canada gets left behind. “Over the long term, our worry is that a country like Canada does better economically in a multi-lateral trade world, rather than the bilateral story that is playing out across the global stage in 2019,” said Wright.

 

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Sources

  1. RBC Investor & Treasury Services' Investor Forum (May 8, 2019) Economic Update
  2. Policy Uncertainty (March 2019) Monthly Global Economic Policy Uncertainty Index
  3. Statistics Canada (April 2019) Labour Force Survey