Outlook 2008 (Canada in-depth): The West is best

Despite the shock of the U.S. slide, the near future looks good for Canada, especially in the West. Here’s why.

The past year has been unkind to businesses selling to the U.S. market. By mid-summer, soaring oil prices and a shrinking U.S. dollar fuelled the Canadian dollar’s rocket ride toward parity with the greenback. Many businesses, particularly exporters to the U.S. concentrated in Central Canada, were already struggling with the surging loonie when they received a second shock: the late-summer meltdown of the U.S. sub-prime mortgage market panicked Americans. According to the Conference Board in New York, confidence among U.S. consumers has fallen by 25 percentage points from its July level, with no turnaround in sight.

With more than 80% of Canadian exports destined for the U.S., it is no surprise that they have become a drag on this nation’s economic growth, notwithstanding the high prices currently enjoyed by commodity exporters. Sectors such as tourism, forestry products, and autos and parts are reeling from the combined effect of a strong Canadian dollar, the sharp slowdown in U.S. housing construction and slower growth in American consumer demand.

Yet despite these shocks, the Canadian economy has coped remarkably well, buoyed by solid growth in real incomes and consumption, and by tax cuts. Strong growth in Western Canada, coupled with the surprising resilience of Central Canada’s economy, bodes well for the outlook in 2008 and beyond.

The remarkably robust national forecast is fuelled by growth in real incomes (i.e., removing the impact of inflation) and in domestic demand that is largely uninterrupted by the events unfolding south of the border. Real incomes are rising, due largely to ever-tightening labour markets. The employment rate is at an all-time high, and the national unemployment rate, at 5.9% for November, is near a 33-year low, despite the recent slower growth in Ontario and Quebec. We are now at the transition point from a labour-surplus economy to an economy facing chronic labour shortages.

As for regional performance, the West remains best. Alberta’s economy has slowed to more sustainable growth rates of 3.4% in 2007 and 3.6% in 2008. Recent announcements of a slower pace of investment in the oilsands are probably good for the province and the Canadian economy as a whole over the long term, since it will remove some of the frenzy from labour and supply markets. B.C. will grow by 3% during 2007–08, based on the strength of incomes from the services sector and the construction boom for the Pacific Gateway initiative, other transportation infrastructure and pre-Olympic preparations. The economic outlook for Manitoba and Saskatchewan is equally solid. Even prospects for Central Canada look surprisingly good. We expect an upward path for Ontario and Quebec in 2008, with each attaining growth of 2.6% — and better prospects are in store for 2009, especially in Ontario. In contrast, Atlantic Canada will strive to attain growth in the 2% range, as aging demographics offset solid investment numbers.

What could derail this rosy outlook? We believe the U.S. will manage to avoid recession, but barely. Strong U.S. export growth, export-based investment and continued job creation will offer enough positive energy to offset the collapse in housing starts and the threat to consumer confidence. Nevertheless, the risks of a U.S. recession are real.

The Bank of Canada also faces a balancing act. Global inflationary pressures are on the rise, fed by high energy and food prices, combined with cost pressures in China and India. With these forces in mind, the Bank of Canada is walking a tightrope between its core mandate — maintaining price stability — and the desire to avoid placing upward pressure on the dollar at a time when the U.S. dollar is weak.

Overall, the fundamentals in labour markets point to strong upward pressure on wages and continued strong consumption growth. The national economy is essentially at full employment, and a labour-market crunch is already evident in much of Western Canada. Despite the mess on our southern flank, the Canadian consumer will keep our economy chugging along.

Glen Hodgson is senior vice-president and chief economist of the Conference Board of Canada.