|| Pedro Antunes
This op-ed was originally published in The Globe and Mail
on January 9, 2019.
It has been 10 years since the 2008/09 recession and financial crisis, which is a long time for any business cycle. Is it time to start planning for the next recession? The answer is yes.
The Conference Board of Canada expects global economic growth to subside next year, and we don’t see a recession in the cards for the United States or Canada in 2019. Still, there are many risks that could derail the economic outlook. The United States has undergone one of the longest expansions in modern history, and some voices are now starting to warn about the imminent arrival of another business cycle.
To assess where the economy is likely to land in 2019, here are five important issues to follow:
Trade Wars and Brexit
Canada is an open economy, dependent on trade, so trade wars add an important downside risk to the global outlook. The world’s two largest economies, the United States and China, are also our top two export destinations—and their tit-for-tat tariffs could significantly boost prices (and reduce the purchasing power) of our major consumer markets, putting the outlook for increased exports at risk. The United Kingdom is our third-largest trading partner, accounting for just more than 3 per cent of exports The U.K.’s economic growth is already slipping, and a hard Brexit would have important repercussions on its economy and on that of the U.K.’s major trading partners in Europe—Germany for example.
Canada’s phenomenal growth in 2017 was driven largely by consumer spending. At that time, low interest rates and hot real estate markets in many parts of the country helped entice households to take on more debt and open their purse strings further. But households will be much more restrained in their spending. Government policies implemented over the past few years, including foreign-buyers taxes, tighter mortgage rules and higher interest rates, have done what they intended—stop rapid home price appreciation. Households will not feel the urge to spend from rising home values, and rising debt charges will take a bite out of spending in 2019. More modest employment and wage growth, coupled with a drop in equity markets, will also hurt household spending, but by how much remains to be seen.
Private Investment Lagging
A big rebound in investment is needed—as the latest available data showed that real private investment in machinery and equipment fell sharply in the third quarter of 2018. We expect that an increase in private investment and exports will help pick up the slack from softer household spending growth in 2019—but will it materialize? Corporations have identified uncertainty about access to the U.S. market, more stringent environmental regulations, diminishing tax competitiveness compared with the United States and a lack of skilled labour as important factors hurting investment intentions. A new trade agreement with the United States and Mexico, and the federal government’s recent move to accelerate the capital costs allowed for investments in machinery and equipment should help offset some concerns.
Low investment levels mean that some Canadian firms don’t have the capacity to meet demand for exports. Despite a favourable exchange rate, strong U.S. growth has not propped up non-energy exports—adjusted for inflation, they have not increased in three years. The typically strong relationship between the U.S. economy and Canadian exports is disconnected. Over the next few years, the outlook for exports will be dependent on the ability of Canadian firms to increase productive capacity, which requires investment.
Regional Divergence ... Again
Over the four years from 2011 to 2014, high oil prices helped Alberta, Saskatchewan and, to some extent, Newfoundland and Labrador, punch well above their weight in contributing to national income and employment gains. The sudden collapse in oil prices in late 2014 drastically reversed the course for those economies. Looking ahead, we expect global oil production to keep expanding, keeping U.S. benchmark prices low and Canada’s oil patch investment muted. Alberta’s recently announced production cuts will have an effect on the province’s oil production in 2019, but the hope is that these cuts will also alleviate transportation bottlenecks and help close the gap between Alberta oil prices and U.S. benchmark prices.
The new year will undoubtedly bring other challenges, but, despite the plan for continuing deficits federally, Canada’s fiscal situation is in better shape that most Group of 20 economies. Moreover, the Bank of Canada has taken steps to normalize monetary policy—while rates have not yet risen to the level the central bank is targeting, there’s at least some room to lower them in the event of another business cycle.
For now, risks of a recession both in Canada and globally are relatively low. If business investment strengthens and households add to savings in 2019, we will be in better shape at the end of next year to tackle that eventual downturn.