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Canada Facing Economic Recession And Political Hard Choices

City_of_lights (1)Earlier this month the government of Canada was finally forced to admit that the country had been in recession for the first half of 2015. The news could not have arrived at a worse time for the incumbent conservative Prime Minister Harper, facing upcoming national elections in October. A number of investors have recently soured on the Canadian economy, reeling from low crude prices and a general global collapse in commodity prices.

National statistics indicate that Canada’s economy contracted 0.08% in the first quarter and 0.5% in the second quarter. It is the only nation among the Group of Seven that is officially in recession, although Japan may well arrive there soon enough. For Canada it is the second recession in seven years and is a warning for any nation, that becomes too dependent on commodities for growth.

Nodding donkey pumping an oil well near Sarnia, Ontario

Nodding donkey pumping an oil well near Sarnia, Ontario

The nearly 20% of the Canadian economy that is tied to energy and other commodities has sustained a major blow as both demand and price have plummeted. The price for Canadian crude has been reduced by nearly 50%, damaging the share value of many leading extraction and production companies in the energy sector.

Canada remains the world’s 5th largest oil producer. However, a full recovery in the industry will await for a rebound in global prices. If a lower price structure in commodities remains in place indefinitely, Canadians will be forced to diversify their economy even further away from this source of revenue and growth.

Incumbent P.M. Stephen Harper since February 6, 2006

Incumbent P.M.
Stephen Harper
since February 6, 2006

There are a number of analysts that predict that the Canadian economy will resume growth in the second half of 2015, possibly reaching 2.5% by the end of the year. This will of course depend greatly on what happens in the United States. The neighbor to the south remains the largest trading partner and if the American economy beings to stall, the recession in Canada will be harder to overcome.

The political consequences for the ruling Conservative Party of an economy in recession cannot be underestimated. The leftist New Democratic Party (NDP) and the Liberals are demanding change and hope to benefit from voter dissatisfaction on October 19th. Despite the rhetoric of job losses, crumbling infrastructure, and an unfair tax system that favors the wealthy, it is not clear what the opposition could do to turn the economy around.

The option they will no doubt suggest will be a return to greater government spending, in order to attempt to stimulate the economy. Of course, this will reverse the prudent fiscal management that the Conservatives have provided over the last decade.

It was not easy to achieve a federal balanced budget and it is not clear that running up new government debt as promoted by the Liberals,will bring the Canadian economy out of recession any faster. Running a $10 billion USD (United States Dollar) plus deficit for the next few years, will have a limited impact on an country that is now estimated to have a GDP (Gross Domestic Product) of $1.873 Billion USD.

North American Free Trade Agreement (NAFTA) Logo

North American Free Trade Agreement (NAFTA) Logo

The NDP also wants to increase public spending which will be financed by a rise in corporate taxes. How raising the cost of doing business in an economy already in recession will bring a return to growth seems nonsensical, but then again it is more political then anything else. It is a pandering to voters about supposed inequality, rather than a sound plan for bringing the country out of the present economic malaise.

The political tinkering with infrastructure spending and stimulus spending will not reverse the massive investment Canada has already made to develop the energy resources of the country. The oil sands production in the west, is no longer commercially viable in the present global glut in supply. It will become profitable once again as word demand increases, but the question is what to do in the meantime?

220px-Athabasca_Oil_Sands_map (2)The production of crude from the oil sands is equal to about 2 million barrels a day. This is a capacity that cannot readily be absorbed, by a slowing global economy. Worse yet, if Iran is able to sell more oil with the lifting of international sanctions, there will be even more supply available on world markets. This does not forebode a rapid recovery in the Canadian energy sector any time soon. Especially if nations like Saudi Arabia, insist on keeping production levels at historic highs to force out competitors.

OPEC (Organization Of Petroleum Exporting Countries) has just recently stated, that the international cartel believes that crude prices will not return to normal levels until at least 2020. That is grim news to Canadian energy producers, since the production of oil sands is much more costly than traditional pumping.

As economic activity shifts from the resource rich west of Canada back to the manufacturing dependent east, there will be a resurgence of some industries. This will be the result of a declining Canadian dollar. This will make imports more expensive, thus providing an extra boost to domestic business. As foreign exchange earnings from Canadian energy decrease, it will subsequently make other sectors of the economy more competitive.

A dairy farm in Obtario

A dairy farm in Obtario

In addition to manufacturing, there will be a revival in a number of industries as widely spread as agriculture, film production and tourism. The leading province of Ontario will benefit the most from this trend. Ontario has watched its share of the national GDP dip to a 30 year low last year. This will now begin to be reversed as the economic fortunes of the province are improved.

The western part of Canada will remain mired in recession and increasing debt, as these provinces deal with the decreasing demand for Canadian commodities from global markets. This is especially the case with China. The stunning drop in Chinese growth is a direct cause of the shrinking need for the natural resources Canada wishes to sell.

Toronto, the financial centre of Canada

Toronto, the financial centre of Canada

This phenomena is creating havoc among emerging markets almost everywhere. Latin America in particular is hard pressed to deal with the lack of global demand for commodities. These economies had become very dependent on this sector to provide domestic economic growth. It is the main explanation that a number of countries in the region are teetering on the brink of recession. Others have already arrived, like is the case with Brazil.

There will no doubt be a movement of population from western Canada back to the east, as job losses in the energy industry continue to mount. As a sign of what is to come Alberta for example, used to a large provincial surplus is now facing a deficit of $6.5 Billion USD this year.

Regardless of which political party wins the upcoming election next month, Canada will still face some very difficult choices. If the voters accede to the well worn sirens call that more government is the answer to bring back growth in the Canadian economy, there will be even more financial trouble down the road.200px-Canada_provinces_evolution_2

If instead the electorate is willing to accept the fact that slower global growth cannot be undone by the politicians in Ottawa, there is hope yet that the economy will somewhat recover on its own. This will be the result of new capital and investment being made in industries and businesses outside the energy sector.

220px-Canada_(orthographic_projection).svg (1)In these circumstances, Canada unlike some of the more profligate developed nations of the world will continue to live within its means. That will mean lower growth in government expenditures for everything from entitlements to defense. It will mean that Canadians unlike many other developed countries at this time, will finally accept the reality that despite what politicians may promise, what is possible is only what is affordable.

Long term sustained growth and investment is only possible when a country learns that the accumulation of debt in the end, becomes a bigger hindrance to economic normalcy than anything else. Interest rates at or near zero and a constant devaluation of national currencies will not return a nation back to prosperity. Neither will the endless rounds of quantitative easing as promoted by many central banks around the world. Far from it. It instead creates a misallocation of resources and punishes savers, who have been the foundation of creating the pools of money needed for new investment.

Canada along with just a few other nations has tried to maintain a more traditional path in fiscal and monetary management. This is what the voters will decide in October. To stay the course despite the recession, or revert back to where more government intervention will somehow make things better. To be fair, it is a hard choice to make in the present economically difficult environment.

Canada Export Treemap by Product

Canada Export Treemap by Product

1 Comment

  1. As a Canadian myself, and one who works in the oil and gas industry, this post was great and spot on. We are already seeing people move away from the west (Alberta) and going back to their home provinces in eastern Canada.

    From a political standpoint, we do need to make sure that we pressure the governments to “get us out of this”. This is not a government problem, but a global supply and demand problem that will take time to work itself out as companies and people reset to the environment we are in with lower oil prices.

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