Tiff Macklem: Global growth and the prospects for Canada's exports
Remarks by Mr Tiff Macklem, Senior Deputy Governor of the Bank of Canada, presented to
the Economic Club of Canada, Toronto, 1 October 2013.
* * *
Introduction
Good afternoon and thank you for the invitation to address the Economic Club of Canada.
Canada has thrived by being open to the world, and having the world open to us. Our
citizens hail from, travel to, and work in countries across the globe. We participate in global
governance, offer our assistance and expertise in disasters and conflict, and, most
importantly for our prosperity, we are traders.
Historically, exports have been an important driver of Canada's economic growth. Today,
they account for about a third of our national income.
This is my topic today - exports. How is global demand likely to shape our export
performance, and what should we be doing to take full advantage of an expanding world
market?
Canada's export performance
To cultivate and serve international markets, our exporters have been smart, creative and
competitive. They need to be. Canadian exporters operate in a global marketplace with
aggressive competitors and a global economy continually in flux. Changes to the geography
and composition of growth over the past dozen years have been nothing less than
transformative. Growth in the emerging-market and developing economies is now outpacing
that of the advanced economies, creating both new markets and new sources of competition.
And the knowledge economy is becoming an important source of trade in services. The
financial crisis has, in many ways, only accelerated these changes.
Our exporters are adapting but it has been gut-wrenching.
In the wake of the financial crisis, our exports were harder hit than in any post-war recession,
decreasing by about 17 per cent over three quarters. This was more than triple the decline
experienced in the 1990-91 recession. Many Canadian exporters either went out of business
or turned inward to Canadian markets. From the peak in 2008 to the trough in 2010, the
number of exporters fell nearly 20 per cent, dropping by almost 9,000 firms.
After a surge in the second half of 2011, exports have again lost momentum, falling back by
about 1.2 per cent. They remain 6.5 per cent or $35 billion below their pre-recession peak,
and more than $130 billion below where they would be in an average export recovery
(Chart 1). There is much lost ground to make up.
This weakness largely reflects anemic foreign demand - this is the weakest post-war U.S.
recovery. But it is being compounded by a longer-term trend: our share of world exports has
been in decline for more than a decade. Since 2000, Canada's share has fallen from about
4.5 per cent to about 2.5 per cent.1 Part of this decline is the inevitable consequence of the
entry of China into global markets. But even allowing for this, Canada has fared poorly. Our
loss of global trade share has been the second largest in the G-20.
Following the financial crisis, the Bank's strategy for monetary policy was to support
domestic demand while the recovery in exports took hold. The first part of the strategy
worked. Final domestic demand recovered quickly in Canada.
But a side effect has been the emergence of imbalances in the household sector, reflected in
rising household leverage, stretched valuations in a number of housing markets, and an
increase in the incidence of highly indebted households. Today, there is a more constructive
evolution of those household imbalances.
This is good news. It reduces the risk of an abrupt and painful correction down the road.
But this new-found and welcome household prudence is dampening growth. To replace this
growth, we need a rotation in demand toward exports and business investment.
Unfortunately, this rotation has proven elusive.
This is consequential - growth in Canada has slowed. In the year leading up to this past
June, growth averaged only 1.4 per cent, compared to 2.6 per cent the year before. With
Canada's potential output estimated to be growing at about 2 per cent, growth in demand
has not kept pace with the expansion in production capacity, and economic slack has
increased.
To absorb the current material degree of slack in the economy, demand needs to grow
measurably faster than supply. That means growth of at least 21⁄2 per cent.
The Bank is currently revising its forecast, and we will publish our latest outlook in our
October Monetary Policy Report. But in broad strokes, we expect household and government
spending together to contribute about 11⁄2 percentage points of growth. So to reach at least
21⁄2 per cent GDP growth, we will need at least a 1 percentage point contribution to growth
from net exports and investment. That means together exports and investment need to grow
by at least about 4 per cent after taking into account their import content.
In the past year, net exports and investment made no contribution to growth.
Conditions are propitious for business investment to accelerate. Corporate balance sheets
are exceptionally strong, and corporate borrowing rates remain very low, even if they are off
their troughs. But investment is unlikely to accelerate until businesses are confident that
demand is picking up.
The key is exports.
As firms see their order books filling up, they will unlock their investment plans. The typical
lag between a pick up in exports and an acceleration in investment is about six months.
So the crucial question is: What are the prospects for our exports?
To address this question, I will start by reviewing the outlook for global growth and the
demand for our exports of goods and services.
Global outlook
Advanced economies are contributing more to growth
The U.S. economy is reaping the benefits of bold measures to repair its financial system and
exceptionally expansionary monetary policy. Private demand has gained momentum, despite
considerable fiscal drag imposed by tax increases and sequestration cuts and a sluggish
labour market.
Household deleveraging in the United States is well advanced. Through a combination of
defaults, increased savings and gains in asset valuation in house and equity prices,
household net worth is now back to 2007 levels (Chart 2).
Housing starts and resales are recovering, and house prices are now up almost 18 per cent
from their trough. The once mighty U.S. consumer is coming back, albeit more prudently, and
this is underpinning growth excluding fiscal policy in the 31⁄2 to 4 per cent range.
Headline GDP growth, however, is much weaker, owing to significant fiscal drag, which we
estimate will subtract 13⁄4 percentage points from growth this year (Chart 3).
While this is dampening GDP growth, our exports are more geared to private U.S. demand,
which is stronger. The recovery in housing, in particular, is creating new demand for
Canadian exports of lumber and building supplies.
In Japan, the Abenomics "Three Arrows" policy revolution has so far produced impressive
results.2 The immediate impact was to push equity prices significantly higher, depreciate the
yen by roughly 20 per cent, generate expectations of positive inflation and push real
longterm interest rates into negative territory. This is now translating into faster growth, which
averaged close to 4 per cent, at annual rates, in the first half of this year. To sustain this
momentum, bold monetary policy measures will need to be followed by more difficult
structural reforms - the third arrow.
In Europe, there are early signs of recovery. The intersecting downward spirals of fiscal
austerity, bank deleveraging, declining economic activity, increasing government debt
burdens and rising non-performing loans are abating. Euro area growth is now positive and,
encouragingly, the structural imbalances at the root of the euro crisis are also showing signs
of improvement. The substantial current account deficits in the peripheral countries have
been largely eliminated (Chart 4) and, more significantly, the competitiveness of the
peripheral countries relative to Germany has begun to improve (Chart 5). This bodes well.
Nevertheless, Europe is far from being out of the woods. Growth is likely to remain subdued
and downside risks remain. Still, the situation is better than it was six months ago, and much
better than a year ago.
Growth in China looks solid, but other emerging markets are losing momentum
In China, growth has slowed to a still-solid pace of 71⁄2 per cent, and confidence is improving.
Growth is being spurred by robust investment, particularly in infrastructure, as well as
expansionary credit conditions. Supported by "consumption-friendly" structural reforms,
growth is expected to rotate toward consumption, although this process is likely to be very
gradual.
In contrast, a number of other emerging markets have experienced increased financial
volatility and weakening growth prospects. Against the background of a steepening U.S. yield
curve, there were broad-based capital outflows across emerging markets through June and
July as investors pulled back from risk (Chart 6). Since then, markets have become more
discriminating, focusing on emerging markets that appear more vulnerable owing to a
combination of current account deficits, inflation and slower growth (Chart 7).
While there has been some stabilization in the financial markets, credit spreads have
widened in these emerging-market countries, and their currencies have depreciated sharply
(Chart 8). To limit the depreciation, authorities in affected countries have responded with a
series of measures to stem capital outflows, including currency interventions, capital controls
and higher policy interest rates. While such measures may provide temporary relief, they are
not without cost. Ultimately, the best defense is undertaking the fundamental reforms
necessary to putting one's own house in order.
Expectations of stable, solid growth in China will support commodity prices, which, overall,
remain high by historical standards. However, the recent slowing in other emerging markets,
combined with some retreat from risky assets, has exerted downward pressure on many
commodity prices in recent months, particularly base metals. In aggregate, commodity prices
are expected to remain relatively stable through 2015, with the effects of modest expected
declines in oil prices offset by a gradual rise in the prices of non-energy commodities.
How will these global developments affect our exports?
To address this question, I will look at our exports from three perspectives: our trade
geography, or who we sell to; our competitiveness in global markets; and our product mix.
Our trade geography
Over the past dozen years, our trade geography has worked against us because our major
trading partners have been growing more slowly than the global economy. From 2001 to
2007, the rise of China and other emerging-market countries outpaced growth in U.S.
demand. The crisis only magnified this. Emerging markets now account for 80 per cent of
global growth (Chart 9). But only 12 per cent of our exports go directly to fast-growing
emerging markets while 85 per cent go to slow-growing advanced economies. Compared
with our peers, Canada's direct exposure to emerging markets is tiny when measured as a
share of exports (Chart 10).
To illustrate the magnitude of this trade geography effect, suppose Canada had the same
level of exposure as the United States to emerging markets (Chart 11). Foreign demand for
our exports would be $60 billion higher.
Going forward, our trade geography should improve as the recovery in advanced economies,
and particularly the United States, gains momentum. Emerging markets are likely to remain
the principal source of growth in the next several years, but as the United States and other
advanced economies recover, they are expected to regain at least part of the share of global
growth that they lost in recent years (as projected in Chart 9). This will be positive for our
exports.
At the same time, Canadian exporters are developing new markets in the fastest growing
emerging markets. One-third of firms report they have already started exporting to new
markets in the past two years, and about half plan to expand into new countries over the next
two years. The top two destinations are Brazil and China.3
In addition to direct exports to developing economies, Canadian exporters are also
embedded in global supply chains. Participating in supply chains means that Canadian
businesses benefit from trade with countries such as India and China not only by selling
directly to them, but also by supplying firms in the United States and other advanced
economies that are selling to the emerging markets. As the pendulum swings from
offshoring to on-shoring, Canadian firms need to secure and grow their presence in global
supply chains.
Our competitiveness
A second factor influencing our exports is competitiveness. Between 2000 and 2012, the
labour cost of producing a unit of output in Canada compared with the United States,
adjusted for the exchange rate, increased by 75 per cent (Chart 12). The majority of this loss
of competitiveness reflects the appreciation of the Canadian dollar (shown in blue), but weak
productivity growth in Canada relative to the United States also played a significant role
(shown in green).
This decline in competitiveness is manifest in our shrinking share of the U.S. market. Not
only did the U.S. import market contract relative to the rest of the world, Canada's share of
that market shrank (Chart 13).
What if we hadn't lost competitiveness? What would our exports be had our competitiveness
stayed at its 2002 level?
If Canada's exports had grown in tandem with those of the U.S. and global economies - in
other words, taking the weakness of the global economy as a given and excluding oil - our
goods exports would have been $71 billion higher (Chart 14).
There are many factors that affect business investment and productivity, including access to
risk capital, the regulatory environment, infrastructure and skills mismatches. This makes
productivity particularly hard to predict. But looking ahead, stronger exports should
encourage more investment and this, in turn, should increase productivity. As firms fully
utilize existing capital, productivity can be expected to rise. And new investment typically
embodies new technologies, so as this new investment comes on line, workers will have
more and better capital to work with. Better tools help make workers more productive, which
should improve our competitiveness.
Our product mix
The third factor is what we export - our product mix. Here, there are two forces at play, which
have been moving in opposite directions.
From 2000 to 2007, strong growth in advanced and emerging economies created strong
global demand for machinery and equipment and consumer goods. This shift in the
composition of global demand did not play to Canada's strengths. Machinery and equipment
and consumer goods are a smaller proportion of our exports than in the average world export
basket.
Commodities, on the other hand, have worked in the other direction. In the last several years,
the boost from the commodity intensity of our exports has turned the product mix effect to a
net positive for Canada, with the rise in our energy exports more than fully offsetting the drag
from machinery and equipment (Chart 15).
Energy commodities have become an increasingly important share of our exports. In 2000,
energy made up 11 per cent of our exports. Today it is almost 20 per cent. And oil is now by
far our most important commodity. Its share of commodity production roughly doubled in the
past decade, to close to 50 per cent today (Chart 16).
But recently, energy transportation bottlenecks in North America have been limiting this
positive product mix effect. While oil sands production is rising steadily, transportation
capacity has become increasingly problematic. All realistic scenarios for U.S. energy
independence include Canadian crude production. But we have to get it there.
In the coming years our product mix is likely to provide less of a boost than it has over the
past five years. As I mentioned earlier, commodity prices are expected to remain relatively
stable through 2015 but some of our export sectors that particularly suffered, such as
forestry, should pick up.
Services exports: a growing opportunity
Finally, let me say a few words about our exports of services. We tend to focus on exports of
goods, but services have the potential to become a more important source of Canadian
national income.
Services already account for 15 per cent or $75 billion of our exports. This is more than
either motor vehicles and parts or machinery and equipment. And unlike motor vehicles and
machinery and equipment, our services exports were relatively stable throughout the
recession (Chart 17).
The global growth of the knowledge economy is changing the composition of our service
exports. We have been - and are - selling the products of our intellectual labours to the
world. This includes management services, computer services and information, financial
services and engineering services. Services being exported range from new apps to security
and training software, data analytics, multimedia, online services, and social media
management systems.
More than 60 per cent or $46 billion of our service exports are commercial services, some
40 per cent of which are purchased by non-U.S. clients. About 50 per cent of financial and
insurance services, one of the largest categories of service exports, go to markets outside
the United States. And while exports of management services to the United States and the
European Union have slowed since 2005, they have grown in other countries. This trend
underscores one of the significant strengths of our services exports: they are more diversified
than our goods exports. More than 20 per cent are to non-OECD countries.
Conclusion
Let me try to summarize. To put a meaningful dent in the remaining slack in the Canadian
economy, we need annual growth of at least 21⁄2 per cent. Achieving this requires a rotation
in demand toward exports and business investment.
The conditions are in place for investment to accelerate but, in an uncertain world, firms need
to see demand pick up before they will commit. An improving global outlook, particularly for
advanced economies, should boost our exports. To fully reap the benefits of this lift, we must
strengthen our competitiveness while developing new markets and securing our position in
global supply chains.
As we said in our September 4 policy statement, uncertain global conditions appear to be
delaying the rotation towards exports and investment. Near-term growth now looks a little
less choppy than initially projected. We are now expecting growth in the third and fourth
quarters of this year to be in the 2 to 21⁄2 per cent range before strengthening next year as
the rotation to exports and investment gains momentum.
There is a risk that this rotation is delayed further. At the same time, some recent surveys
and other evidence, including the pick-up in firm creation, suggest that firms are becoming
more optimistic. And once the sequence of stronger exports, rising confidence, increased
investment and stronger productivity is launched, it could well gain traction faster than
expected. We will be monitoring this dynamic closely.
With inflation subdued, monetary policy remains highly stimulative to provide time for the
recovery in exports and investment to take hold.
This is not the first time we have faced the challenge of restoring our exports against shifting
global tides. From beaver pelts to building materials, we have experienced plunges in the
markets for our goods. We recovered by developing new goods and services and entering
new markets. There can be no doubt that we have the entrepreneurial spirit, the skills, the
educated work force and the expertise to compete successfully in the global marketplace.
But that does not make it easy.

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