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Canada’s economic performance has been among the best in the
OECD as a sound policy framework has enabled the country to
take advantage of strong global growth and soaring terms of
trade. The economy has adapted well to recent shocks, as
labour and capital have shifted rapidly from manufacturing
towards the resource and service sectors, with strong net
job increases. Overall supply has benefited from rising
participation rates. Inflation has been held in check thanks
to appropriate monetary policy settings. Budget surpluses
have enabled major debt and tax reductions. More recently,
though, activity has slowed sharply in response to the
combination of the US downturn and stresses from the high
Canadian dollar, as declining net exports have nearly offset
still strong domestic demand. Significant challenges also
lie ahead. Demographic ageing will put a premium on longer
working lifetimes and faster productivity gains, which have
been relatively weak, to sustain per capita income growth
and public finances. Sustainable growth also requires
successfully addressing the problem of climate change,
notably in the important energy sector.
 A long period of record high
growth in Canada appears to have now ended with the global
financial market dislocation and cyclical slowdown. A
positive terms of trade shock (well over $100 oil and
exchange rate parity with the US dollar) has
meanwhile boosted incomes and energy sector prospects but
also dragged down export values, especially in
manufacturing. A key macroeconomic policy challenge will be
to balance upside risks to inflation in the medium term and
downside risks to growth in the short run, while ensuring
that symptoms of Dutch disease do not develop. Realising
Canada’s full potential in the face of imminent demographic
ageing requires later retirements and overcoming a
persisting productivity gap vis à vis the United States via
structural policies. Looking further into the future,
Canadian and world welfare will depend on curtailing present
levels of greenhouse gas emissions. The highly emitting
energy sector, in particular, is not sustainable on current
development patterns. Outdated policies in the agricultural
sector also distort Canada’s natural comparative advantage
in food while denying domestic market access for poorer food
producing nations. Given its many advantages, there is no
reason Canada cannot successfully deal with the challenges
posed by new terms of trade, ageing and climate change.
The economy has been remarkably strong in recent years
The Canadian economy has performed remarkably well for the
past decade and a half. Real GDP growth has been robust,
employment gains have been impressive, the unemployment rate
has fallen to its lowest level in a generation, and positive
terms of trade effects have combined with real per capita
output growth to boost Canadian living standards.
Furthermore, higher commodity prices have led to a rapid
appreciation in the dollar back to around parity with its US
counterpart, helping to discipline wage and price setting
and meet the official inflation target.
 Domestic price
inflation has also been held in check by expanding
production capacity, thanks to rising female and older
worker labour force participation, which has more than
compensated for relatively weak productivity growth.
However, high commodity prices and the resulting currency
appreciation have been forcing rapid economic adjustments
through industrial and regional employment shifts. Most
signs point to orderly adjustment – even resource poor
regions have seen overall employment gains, despite
substantial losses in manufacturing.
But it weakened toward the end of 2007
Most recently, the currency appreciation, together with the
worldwide turmoil in credit markets and associated weakening
in foreign demand, has caused a sharp drop in Canada’s net
exports, slowing growth to a crawl. Looking ahead, the US
downturn is expected to continue to exert downward pressure
on Canada’s GDP growth through the trade and credit
channels, but the economy should rebound somewhat in 2009.
Risks are skewed to the downside and mostly derive from
large uncertainties regarding the future path of the US
economy and its currency and the extent of the financial
market correction that will ultimately occur there. In any
case, it is likely that economic slack will open up,
alleviating residual price pressures and holding inflation
well below rates seen abroad. This will allow the Bank of
Canada room to lower interest rates further, helping to
return output to its potential level as quickly as possible.
The key challenge is to continue adjusting smoothly to
global shocks, while raising productivity growth and
curtailing GHG emissions
Policy makers are struggling with an unprecedented series of
global shocks and risks. Oil, food and other commodity
prices have increased almost uninterruptedly for the past
five years – mainly reflecting rising global demand rather
than temporary supply disruptions as in the past. As a
commodity exporter Canada can easily learn to live with a
quasi permanent high oil price – but it must also adjust to
the corresponding downside of a strong Canadian dollar and a
weaker US economy. Meanwhile, demographic ageing is
underway, implying that employment – up to now a mainstay of
growth – will be shifting into a lower gear while pressures
on age related public spending will build. At the same time
climate change risks have intensified; Canada’soil sands
sector, a fast growing emitter of GHGs, faces the uncertain
costs of planned abatement policies, as do other investors.
Three key structural challenges, roughly corresponding to
the short , medium and
long term policy horizons, emerge:
»
The
structural shift provoked in part by the terms of trade
shock may be one of unparalleled magnitude in Canada’s
modern history. It must continue to be managed in a
sustainable way, notably to prevent excessive crowding out
of exposed sectors like manufacturing and forestry by other
natural resource production and the public sector as they
benefit from oil and other commodity price windfalls.
»
While
greater labour force participation, especially of marginal
groups, longer working lives and immigration can still be of
use in boosting labour supply, the looming rise in the old
age dependency ratio means that the onus will increasingly
be on higher productivity growth to maintain rising living
standards and sustainable public finances.
» Climate
change and Canada’s commitment to joint global action in
fighting it requires a switch to a model of sustainable
development, i.e. much less energy intensive consumption and
production patterns, notably in the energy sector itself.
Source:
Organisation for economic co-operation and development,
Economics department, Economic survey of Canada 2008 |
