The Canadian Economy:

1

The Canadian Economy Recession, Recovery and
Transformation
APEGGA April 23, 2009 Glen Hodgson Senior
Vice-President Chief Economist hodgson_at_conferenc
eboard.ca
2
Three Themes for Today

• The economic outlook in exceptional times
• The financial crisis
• Transformation what will the world look like
  after recovery?

3
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

4
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

5
U.S. Existing Home Sales and Prices (millions
SAAR 000)
Source National Assn. of Realtors.
6
U.S. Labour Market(Change in U.S. Employment,
000s)
Source Bureau of Economic Analysis.
7
U.S. Consumer Confidence Lowest in
History(1985100)
Source The Conference Board Inc.
8
U.S. Real Consumer Spending Growth(per cent
change, annualized)
Sources BEA CBoC
9
US Federal Deficit(Unified, billions)
Sources BEA Moodys Economy.com
10
U.S. Real GDP(per cent change)
Sources BEA CBoC.
11
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

12
Raw Materials Price Index (per cent change)
Sources The Conference Board of Canada
Statistics Canada
13
Real Exports (per cent change, 200010)
Sources The Conference Board of Canada
Statistics Canada.
14
Interest Rates (90-Day T-Bill) Quarterly 199911
U.S.
Canada
Sources The Conference Board of Canada BEA
Statistics Canada.
15
Exchange Rate 200010U.S. cents per Canadian
dollar
Sources The Conference Board of Canada
Statistics Canada.
16
Index of Consumer Confidence, CanadaJan 2003Mar
09 (2002 100)
Source The Conference Board of Canada.
17
Employment Growth Canada, 200010
340,000 job losses
Sources The Conference Board of Canada
Statistics Canada.
18
Unemployment Rate vs. Natural Rate (percent),
1981-2013
Unemployment Rate
Natural rate
Sources The Conference Board of Canada
Statistics Canada.
19
Unemployment Rate vs. Natural Rate (percent),
1981-2013
Unemployment Rate
Natural rate
Sources The Conference Board of Canada
Statistics Canada.
20
Real Consumer Spending Growth Canada 200110
Sources The Conference Board of Canada
Statistics Canada.
21
Housing Starts vs. Demographic Requirements
Canada 200110 (000s)
Household formation
Sources The Conference Board of Canada Canada
Mortgage and Housing Corporation.
22
PreTax Corporate Profits(per cent share of net
domestic income)
18 per cent in 2008Q3
Sources The Conference Board of Canada
Statistics Canada.
23
Real Business Investment Growth (Canada 200110)
Sources The Conference Board of Canada
Statistics Canada.
24
Federal and Regional BalancesNational Accounts
Basis ( billions)
Sources Statistics Canada The Conference Board
of Canada.
25
Real Government Spending on Goods and Services
Canada (per cent change, 200010)
Sources The Conference Board of Canada
Statistics Canada.
26
Real GDP Growth Rate Canada 200109
Sources The Conference Board of Canada
Statistics Canada.
27
Conclusions

• Some signs that key U.S. markets are nearing
  bottoma 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

28
The Financial Crisis A Perfect Storm

• Two underlying conditions
• Global savings investment imbalances
• Massive global savings available Asia and oil
• Supported by accommodative U.S. monetary policy
• Unconstrained financial market innovation and
  leveraging
• Insufficient financial market regulation at all
  levels
• New financial instruments (securitization, credit
  swaps)
• Global distribution networks

29
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

30
Global Action, SeptOct 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

31
Credit Spreads Have Stabilized(3-month Libor
minus 3-month US T-bills)
Source Moodys Economy Inc.
32
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

33
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

34
Short-term Interest Rates (per cent)
Source Consensus Economics.
35
Spread between High Yield Debt and 10-Year
Treasury Notes
Inc.
36
Federal Reserve Balance Sheet(total assets,
billions)
Source FRB.
37
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 cant pay from wont pay ?

38
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 cant pay from wont pay ?

39
The Feds 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

40
And Room for Even More

• Obama budget for 0910 includes another 250
  billion on-budget for re-starting credit
• Price tag so far 10 trillion and rising
• And the bottom is not yet reachedmore to come
  through 09

41
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

42
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

43
Direct Government Intervention (cont.)

• Canadian Secured Credit FacilityFed 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

44
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)

45
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

46
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 bankswhile 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

47
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.

48
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

49
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

50
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 wont 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)

51
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

52
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

53
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

54
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

55
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

56
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

57
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 RD etc

58
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?

59
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

60
Conclusions

• We are about half-way through the current
  financial mess and recession
• The Canadian recovery is not here yet but its
  on the horizon
• The world will not be the same as we emerge into
  recovery
• So be ready to dance on your toes!

61
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

62
Population of Those Aged 65 and Over(per cent
share of total population)
Sources United Nations Statistics Canada.
63
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

64
Population Distribution by Age, 2007
Sources The Conference Board of Canada
Statistics Canada.
65
Source Population Growth(per cent change,
compound annual growth)
Sources The Conference Board of Canada
Statistics Canada.
66
Population Distribution by Age, 2030
Sources The Conference Board of Canada
Statistics Canada.
67
Labor Force Participation Rate (per cent,
1985-2030)
Sources The Conference Board of Canada
Statistics Canada.
68
Labour Force Growth(per cent change, compound
annual growth)
Sources The Conference Board of Canada
69
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

70
Machinery and Equipment Investment Growth(per
cent change, compound annual growth)
Sources The Conference Board of Canada
Statistics Canada.
71
Private ME Investment (share of total GDP)
Sources The Conference Board of Canada
Statistics Canada.
72
Non-Farm Private Labour Productivity(per cent
change, compound annual growth)
Sources The Conference Board of Canada
Statistics Canada.
73
Real GDP Canada (per cent change, compound
annual growth)
Sources The Conference Board of Canada
Statistics Canada.
74
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

75
Invest in Education and Skills

• Canadas education system gets an A in The
  Conference Boards 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

76
Expenditures on Public Education as a Share of
GDP(per cent)
Source OECD.
77
Adult Literacy ProficiencyProportion with
Low-Level Skills (per cent)
Sources The Conference Board of Canada OECD.
78
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

79
Productivity A Conceptual Policy Framework
North American Integration
International Trade Investment
80
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

81
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