Canada Runs Out of Steam

Canada, a country gifted with vast tracts of land, natural resources, and a more-than-friendly relationship with the world’s largest superpower, votes for its next leader on October 19th. While previous elections have been rather dull affairs, the current election comes at a time when Canada’s economy, long having been buoyed by lofty oil prices, low interest rates, and a strong currency, enters a technical recession as China’s economic engine sputters. Whatever the election outcome, Canada’s next leader will be in a punishing fight against its greatest economic challenge since the early 90s.

Stephen Harper, leader of Canada’s Conservatives and of Canada since 2006, has done little to leave Canada’s economy resilient to the current commodity price shock; the merits of his government’s fiscal policy being meager at best. Rather than diversifying the Canadian economy away from real estate, construction, and oil while commodity revenues remained high, the federal government instead pursued a laissez-faire fiscal strategy and lauded itself on merely reducing taxes and reinvesting into further resource extraction.

The short-term thinking in Harper’s loose economic policy has weakened Canada’s manufacturing sector. Once considered attractive due to its proximity to the United States, high quality of output, and reduced labor costs, employment in the sector in 2010 dropped to its lowest levels since 1976. And although Canada’s currency has now fallen against its major trading partners, unlike in other decades, its manufacturing sector can no longer rely on a lower currency to secure an increase in export volume, given that other countries like China and Mexico have become increasingly competitive.

Many economists have declared Canadian housing prices to be unsustainable (“Downtown Vancouver Sunset” by MagnusL3D)

A Bubble Unpopped

Neither can the Canadian economy be driven by domestic consumption, having already squandered vast amounts of credit provided by historically low interest rates on real estate. Canadians, following a long-told narrative to purchase homes, have helped to drive national housing prices to three times its price from 2002; its real estate market having avoided the housing crash of its southern neighbor. Correspondingly, the average household debt-to-income ratios have risen to 165 percent, the same levels of debt that immediately preceded the fall of the US housing bubble and which leaves little margin of error against preventing a housing crash when interest rates begin to rise.

That day may come sooner than later. As prices within the country begin to reflect Canada’s depreciating currency, core inflation (inflation without food and energy) has already risen to 2% over the past calendar year. Were inflation to increase any higher, the Bank of Canada (equivalent to America’s Federal Reserve) would be apt to raise interest rates, increasing borrowing costs, reducing housing demand, and potentially precipitating a hard landing in the real estate market. With the Bank of Canada Governor Stephen Poloz recently declaring that borrowers and bankers “bear the ultimate responsibility for their own decisions”, it leaves the careful management of a slowing economy, an interest rate rise, and precariously high housing prices in the hands of the government.

Canada’s University of Waterloo houses the country’s top Mathematics, Computer Science, and Engineering programs. The Canadian economy should direct its focus on commercializing innovation born out of institutions like these.

Instilling Animal Spirits

Whomever takes the reins of Canada’s highest legislative seat will need to quickly and sharply direct its economic policies to avoid the risk of an otherwise deeper recession, with special focus on increasing economic diversification. Rather than falling back on mid value manufacturing, given its educated workforce, Canada ought to do well in more innovative industries such as biotechnology, software, renewable energy, and high value manufacturing, all of which have in the last decade largely been neglected in favor of resource extraction and whose workers have in large numbers moved to the US.

In an effort to grow such industries, Canadians should emulate their more brazen American counterparts (much to the chagrin of Canadians) and foster innovation and entrepreneurial fervor through government programs and incentives. Policies that encourage output from research centers and universities to be commercialized, the provision of monetary incentives towards select industries, and establishing an entrepreneurial ecosystem replete with well-funded and connected investors could provide Canadians an attractive alternative to established occupations and grow nascent industries into global powerhouses.

Whatever the solution may be for Canada’s economic ills, it’s clear that Canada cannot continue on its current direction. Relying on real estate, construction, oil, or consumption as growth drivers will drive its currency lower, diminish its global economic importance, and lead Canada towards a hard landing as real estate values inevitably deflate, oil prices falter, and credit diminishes.

What is proposed instead is a bold economic policy brought forth by its next leader in which Canada’s economy is quickly and forcefully diversified towards more highly-valued industries, whether they be pharmaceuticals, wind mills, or robotics, in an effort to maintain at least a modicum of growth. An already difficult pill to swallow by some, accomplishing the above in a minority government will make the effort much more difficult. But regardless of what sort of government Canadians will wake up to on the day after the federal election, they will undoubtably face a leaner, harsher economic reality, and together must find a long-forgotten audacity within themselves to overcome it. Perhaps, that is indeed, Canada’s biggest challenge.