From a speech entitled "Dutch Disease"
Spruce Meadows Round Table, Calgary
September 7, 2012
The Bank’s view is that a large, sustained increase in demand is the primary driver of elevated prices. Rapid urbanization underpins this growth. Since 1990, the number of people living in cities in China and India has risen by roughly 500 million, the equivalent of housing the entire population of Canada every 18 months. Despite the current sharp cyclical slowdowns in China and India, this secular process can be expected to continue for decades.
So, even though history teaches that all booms are finite, with convergence to Western levels of consumption still a long way off, the demand for commodities can be expected to remain robust and prices elevated.
Regardless of the cause of a commodity-price increase, Canada’s improved terms of trade cause income, wealth and GDP to rise.
When the source of the commodity-price increase is stronger US demand, the impact on Canadian GDP is greatest. This is because the improvement in Canada’s terms of trade is strongly reinforced by greater demand for our noncommodity exports. In fact, this additional demand more than offsets the competitiveness losses in manufacturing and services stemming from higher wages, higher resource prices and a stronger dollar.
This scenario is the commodity cycle as we used to know it. It is fast becoming a historical artefact.
When, as is now the case, stronger demand from emerging Asia is the cause of the rise in energy prices, the net increase in GDP is one-third of the impact of the US demand shock. This more muted response is because Canada has relatively little direct exposure to these export markets. Therefore, there is less additional demand to offset the competitiveness effects.
Our reliance on the United States, which still takes nine times as many of Canada’s exports as do fast-growing emerging-market economies, is an issue only if we expect US underperformance relative to both history and the rest of the world to continue. Unfortunately, that is what we must expect for some time, as the United States goes through a difficult adjustment process.
The only way to recover the beneficial correlation between commodity prices and demand for Canadian manufacturing exports is to diversify our export markets toward fast-growing emerging markets. That is one of the many reasons why Canada is pursuing an aggressive, emerging-market-focused trade strategy.
It is important to recognize that, for almost all the provinces, trade inside Canada has grown fast enough to offset a significant portion of the declines in international trade. Central Canada, for instance, suffered a real decline in international exports of $18 billion between 2002 and 2008, which was almost entirely offset by increases in interprovincial exports of $16 billion.
Some of this reflects increased sales to Western Canada from Central Canadian machinery makers, primary metal producers and chemical companies. Much of the gains in interprovincial trade volumes were in services rather than goods, which was where most of the declines in international exports occurred.
However, the real prize may be in emerging markets, which contain an estimated 85 percent of the resource productivity opportunities in the world. The scale of the resource opportunity and the challenges of succeeding in a fiercely competitive global economy are some of the reasons why the Bank expects sustained business investment.
Since the start of the recession, total Canadian business investment has been below average, while investment in machinery and equipment has been near average, in comparison with other postwar recoveries. With Canada having the strongest balance sheets on record and benefiting from one of the most resilient financial systems in the world, the need for Canadian firms to build additional precautionary cash balances appears limited.
There is a balance between prudence and action. Yes, there are immense uncertainties in the world economy, but we need to focus on what we can control.
We can’t save the euro, fix America’s fiscal cliff or restart their housing market. Should we just wait out a decade-long deleveraging process in the crisis economies? Should we lower our expectations? Or should we control our destiny by building on our strengths in the new global environment?