Stephen S Poloz: Turbulent times for trade
Remarks by Mr Stephen S Poloz, Governor of the Bank of Canada, at the Baffin Regional
Chamber of Commerce (BRCC) and the Nunavut Mining Symposium (NMS), Iqaluit, Nunavut, 1
April 2019.
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Introduction
It is an honour and real privilege to be here in Iqaluit, the territorial capital, today: Nunavut's 20th
birthday. Over the past two decades, Nunavut has become a real destination, proud to
demonstrate its culture, traditions and values to the rest of Canada, and to the world. There is
tremendous potential here and I look forward to watching you continue to achieve it. So, happy
birthday!
I'm here today to talk about trade. Canadians have always understood trade, because we have
to. Without trade, Canada would never have become a nation of more than 35 million people with
a modern, diversified economy. And as people here know well, trade will always be absolutely
vital to the future of the North.
Back in the 1860s, when the United States imposed tariffs on our exports, the provinces reacted
by uniting in Confederation. In effect, we chose to grow our national economy by building
infrastructure and increasing interprovincial trade. Since the 1940s, though, Canada has
consistently advocated for more liberalized international trade, even while allowing interprovincial
trade barriers to persist, or even to increase.
Our dependence on international trade makes recent developments on this front very worrisome.
The United States has imposed tariffs on steel and aluminum imports from many countries,
which, in turn, have placed countermeasures on a wide range of US products. The United States
is engaged in a trade war with China, and extensive measures have been taken on both sides.
NAFTA has been renegotiated, but the new agreement still needs to be ratified. Europeans are
waiting to see whether the United States will make good on its threat to impose tariffs on their
auto exports.
In short, there has been a significant increase in uncertainty around the future of the global
trading system. This is having an impact on business confidence worldwide. Data from 47
countries-representing more than 80 per cent of the global economy-show that exports and
business investment slowed sharply late last year. If a company cannot rely on international trade
rules, it is not going to make investments to expand capacity and fuel economic growth.
Canada's economic growth slowed late last year, and this weakness is extending into 2019. Part
of this is due to developments in our oil sector and in our housing sector, but the broader effects
of trade uncertainty on investment are clearly there. Fortunately, our economy also has areas of
strength that are providing a cushion. Some services exports have been growing strongly. More
than 350,000 jobs were created over the past year. Indeed, labour income grew by almost 5 per
cent in the fourth quarter. The data are currently giving us a mixed picture and need to be
carefully monitored. But the deeper question we face is whether Canada can continue to thrive
as a trading nation.
Trade and globalization
To address this question, we need to put recent trade developments into context. Trade growth
has generally fallen short of expectations since the global financial crisis a decade ago. To
understand this, we must first understand why international trade grew so rapidly in the years
before the crisis.
International trade began to accelerate during the 1990s as companies took advantage of
opportunities provided by new technology and trade liberalization. Many firms found efficiencies
by breaking down their products into components. This allowed for unprecedented levels of
manufacturing specialization, with components sourced from wherever in the world it made the
most sense.
Instead of a domestic assembly line, you had a complex international value chain. A final product,
like a car made in Oshawa or a cellphone assembled in Mexico, might have contained many
components that were traded internationally several times. Then the final product was exported,
too. This is why international trade rose relative to gross domestic product during this period. As
economists would put it, the trade intensity of goods increased.
Global trade really took off after China joined the World Trade Organization in 2001. With a
massive supply of low-cost labour, China became key to many companies' value chains, and
trade intensity grew even further. This gave rise to concerns that all manufacturing would move
to developing economies. But there was always a natural limit to this offshoring process. A
manufactured product can be fragmented only so far, and some pieces require more labour than
others. This is what determines where best to produce each component.
A manufacturing process that requires many workers and only a bit of machinery can often be
made cheaper by moving it to a country where wages are low. But a process that has a lot of
complex machinery and relatively fewer workers is much less likely to move to a lower-wage
country. Importantly, companies must also take into account the relative productivity of workers
in various countries. In other words, even if workers are paid more in one country than another,
they may be more productive, giving them a comparative advantage over less-productive,
lowerpaid workers elsewhere. It is this complex balance of factors that leads to a natural distribution of
value chains around the world.
Furthermore, economies never stand still. In China, for example, globalization has led to a steady
increase in wages. And this reduces the incentive for firms in advanced economies to move
production there, even if that production is labour-intensive. At the same time, advances in
technology have allowed firms to automate manufacturing more. This means a higher capital
intensity, which also reduces the incentive to move production to lower-wage countries.
In short, these trends have made the cost of labour less of a factor in deciding where to locate
global value chains. Indeed, some companies have moved production back to advanced
economies, a process called reshoring. Often the motivation is to have production located closer
to the ultimate customer, an action sometimes called nearshoring. Or, it may make more sense
to locate closer to the source of raw materials.
For various reasons, then, we have seen some global value chains become more simplified and
a reversal of some of the fragmentation of manufactured products we saw 20 or 30 years ago.
As a result, components are crossing fewer borders in the assembly process. Trade intensity
has eased, and we see a slowing of trade growth around the world.
A detailed study published earlier this year by the McKinsey Global Institute sheds light on these
developments. McKinsey looked at 23 different industries across 43 countries over 22 years. It
found that many goods-producing value chains are becoming less trade-intensive as they locate
closer to their customers. And as emerging markets like China develop and consume more of
what they produce, companies are building more domestic value chains.
The bottom line is that the evolving nature of globalization is contributing to slower growth in
international trade. This is true for the global economy generally, and for Canada specifically.
That said, there are other factors specific to Canada that have been holding back trade in recent
years. They include a loss of exporting capacity in certain sectors and competitiveness
challenges in others. I will come back to this later.
The seen and unseen growth of services
First, though, I want to broaden our discussion of trade. So far, I have been describing trade as
shipments of tangible goods. This is how most people think of it, and my story about globalization
and value chains clearly envisioned a complex product, like a car or a smartphone.
Tangible goods also include products like oil, nickel, canola, pork or lumber. We sell over $500
billion in merchandise to the world each year. Natural resources and agriculture will always be an
important base for our economy, as the folks here today from the mining sector know full well.
Despite recent difficulties, energy products remain our number one export category, at over $80
billion per year. We can continue to find new customers for these products and grow those
businesses over time.
But, as we just saw, economies are constantly evolving. Growth in Canada's economy, which
was based on trade in natural resources in its early years, is now driven mainly by service
industries. Roughly 80 per cent of Canadians are now employed in services, and trade in
services has been growing at a much faster pace than goods. Today, we sell about $120 billion
per year in services to the world.
For example, Canada is a world leader in the mining services sector, with almost 4,000
companies providing engineering, environmental and other professional services. These
categories had exports worth about $12 billion last year. Canada has long been an important
exporter of financial services-last year these totalled about $13 billion and supported many
wellpaying jobs in Canada. Tourism exports are worth around $25 billion per year. This category
includes exports of education services to visiting students-valued at about $8 billion annually.
And on the cutting edge, Canada is becoming known as a global heavyweight in video games,
employing more than 21,000 Canadians, with above-average salaries. Many service sectors saw
exports growing at near double-digit rates or faster, including financial services, the telecom,
computer and information sector, intellectual property and tourism.
As large as these numbers sound, services trade is difficult to track and probably
underestimated. For example, many manufactured products include a large services component
that is buried in the price. By some estimates, as much as 30 per cent of the value of goods
exports is actually created through services.
Consider a smartphone. The parts and labour needed to assemble it might constitute less than
half of what the consumer will eventually pay for it. Most of the difference represents the cost of
all the software that is loaded on the phone.
Here is another example. Many companies today purchase back-office computing services on
the cloud. Previously, a company may have invested in equipment and software and hired
specialized staff to perform these functions. By purchasing cloud services, the company saves
those expenses and boosts its productivity. This is clearly positive for the economy, yet our
conventional statistics show a drop in investment and in trade.
Resolving the mixed picture
I mentioned before that many countries have seen a slowdown in trade and investment, mainly in
response to trade uncertainty. At the same time, many countries are seeing strength in their
labour markets. It is worth considering whether the shift in economic growth toward technology
and services is playing a role.
In Canada, the job market appears to be in great shape. The unemployment rate is near historic
lows and the participation rate of prime-age workers-those
25-54 years old-has never been higher. The number of working Canadians increased by a
healthy 2 per cent over the past 12 months. And a sectoral breakdown shows this growth is
being driven by several key service industries.
Start with the professional, scientific and technical worker category. This includes programmers
and software engineers. More than one million Canadians work in this category, which grew by 7
per cent over the past year.
Then there are categories like education, health care and public administration. Together, these
industries employ about 5 million Canadians. Including two more sectors-transportation and
warehousing, and business and other support services-brings us to more than 8 million
Canadians-that is about 45 per cent of the workforce. The weighted average of job growth
among these categories was 4.6 per cent over the past year, more than double the rate of the
entire economy. This is behind the strong increase in labour income we have seen.
These data suggest that the mixed picture offered up by the Canadian economy today reflects
some important structural changes beneath the surface. In particular, our oil sector continues to
adjust to global oil prices of around US$50-60 per barrel. It is important to remember that only
five years ago it was a widely held view that oil prices would remain far higher than that. Plans
were made, investments were deployed, and it will take time for the sector to adjust fully. The
situation is made more complicated by capacity constraints for oil exports. When the dust
settles, oil will remain a very important sector for the Canadian economy. But the adjustments
are weighing on investment, exports, and wage performance.
Technological advances may also be prompting similar adjustments for a wide range of
economic sectors. Automation puts certain jobs at risk-from manufacturing to financial advising
-holding back wage increases and inflation. But it also creates new jobs for those who write the
software or maintain that advanced technology, and those wages rise rapidly. The people earning
those wages spend them on all sorts of goods and services, creating demand in traditional
sectors including construction, transportation, maintenance and so on. As these adjustments
proceed, there are now more than 500,000 job vacancies in the Canadian economy. Judging
what all this means for the outlook for inflation is of course a challenge for us.
The risks posed by trade wars
But that challenge pales in comparison to the one posed by the possibility of a global trade war.
We have been highlighting this risk to the outlook for the past two years. At the same time, we
have said that the global economy could get a significant lift if trade peace were restored.
The likelihood of trade peace breaking out seems to fluctuate almost daily. Even so, the global
economy has been dealing with heightened uncertainty over trade policy for an extended period
now. Over that time, some business investment decisions have been scrapped entirely or made
in a distorted situation. Even if the uncertainty lifted completely tomorrow, these decisions could
not be reversed, and some of the damage done over the past two years would remain.
People who advocate for protectionism through tariffs tend to miss a basic point. When a country
imposes tariffs on imports, those tariffs are paid by its own consumers and companies. A few
people involved in the protected industry might benefit from the tariffs, but the economy is worse
off overall.
Bank of Canada staff analyzed the impact of the trade actions that have already been taken.
They have found that the various actions will lower economic output while raising prices. In other
words, a trade war is stagflationary. Of course, it is possible that unilateral tariffs will boost
production in the economy that imposes the tariffs, but that is usually a temporary effect, as the
impact on consumer purchasing power affects everyone. More importantly, a unilateral tariff
rarely stays unilateral for long. Companies facing tariffs on their exports will appeal to their own
governments to level the playing field by applying countermeasures. Such retaliation is
understandable, but in the end, the global economy will be worse off, and so will many innocent
bystanders.
Opportunities and adjustments
It is possible that we will have to deal with frictions in the global trading system for some time yet.
Even so, as we said in January, we expect that both exports and investment will return to positive
growth later this year. Since the start of the year, the labour market has continued to show
strength. The adjustments underway in our oil sector will eventually be completed. And firms tell
us that they need to make new investments, and the recent rules around capital cost allowances
are likely to speed that up.
The Bank's role in this process is to maintain a predictable environment for decision making. We
have learned from experience that keeping inflation low, stable and predictable is the best
contribution we can make to Canada's economic welfare. Crucially, our inflation-targeting
framework includes a floating exchange rate that helps our economy adjust to external shocks.
We only have to look back a few years for an example. Following the oil price collapse of 2015,
movements in the exchange rate helped to offset the loss of jobs in the oil sector by boosting
exports in other sectors.
In addition to the solid economic base that comes from our natural resource sectors, we have
numerous advantages we can use to create new economic growth. Among other things, we
have a well-educated and diverse workforce that is growing through immigration. And, we have
trade agreements like the Canada-United States-Mexico Agreement, the Comprehensive
Economic and Trade Agreement with the European Union, and the Comprehensive and
Progressive Agreement for Trans-Pacific Partnership. These agreements should help to buffer
us from some of the negative trade developments I mentioned at the beginning.
Another possible buffer lies right here at home. Recall that when the United States turned
protectionist in the 1860s, we responded by uniting our own economic clout through
Confederation. In today's trade-uncertain world, it is even more important that we continue to
make progress in promoting trade among our own provinces and territories. And enhancing
economic links between North and South is even more urgent, given the growing risks around
climate change. You are already feeling the impact of climate change here, and it will affect
almost every aspect of life in the North. Lowering barriers to trade could certainly help mitigate
these economic impacts.
The good news is that trade in services among the provinces has been growing rapidly over the
past 10 years and is already larger than interprovincial goods trade. The bad news is that goods
trade between provinces has basically been stagnant for a decade.
To make this point concrete, Bank staff estimate that Canada's potential economic growth would
increase by about 0.2 percentage points per year, or about $4.5 billion, if interprovincial trade
barriers were lowered. This would include harmonizing regulations on all manner of things. In a
time of slow economic growth, that is too good an opportunity to pass up.
Conclusion
It is time for me to conclude.
Clearly, there are challenges in the Canadian and global economies that we need to manage. But
there are clear signs that Canada is adjusting to the challenges. After taking into account the
economy's structural adjustment to lower oil prices that is still going on, we can see many areas
of encouraging economic growth. These are both traditional and cutting-edge, and are
exportoriented. Canada's portfolio of trade agreements should serve us well as this story unfolds,
despite the uncertainties the world faces today.
That being said, it is clear that the global economy is performing less well than we believed only a
few months ago, and Canada is feeling the effects. In addition, our housing sector is taking
longer than previously expected to digest the combined effects of stricter mortgage guidelines
and higher interest rates.
That is why we said at our last interest rate announcement in March that the economic outlook
continues to warrant a policy interest rate that is below the neutral range, to help the economy
work through this downshift in growth and keep inflation close to target. Recent economic data
have been generally consistent with our expectation that the period of below-potential growth will
prove to be temporary.
Our next interest rate announcement and Monetary Policy Report will be released on April 24,
and I can promise a fuller analysis at that time. For now, let me thank you for your kind attention,
and for your wonderful hospitality here in Iqaluit.