Is Canada decoupling from the U.S.? - June 6, 2007
By Stephen S. Poloz, Senior Vice-President, Financing Products Group, Export Development CanadaListen to the Weekly Commentary podcast.
RSS | iTunesRecent figures show that the U.S. economy did a face-plant in 2007Q1, while Canada was humming. This has cemented the perception that Canada is decoupling from the U.S.
The matter clearly deserves a closer look. True, the U.S. economy has been experiencing a slowdown, led by a collapse in its housing sector, and posted GDP growth of only 0.6% (at an annualized rate) in 2007Q1. Meanwhile, Canada posted a first-quarter growth rate of 3.7%. Not only is this a very large gap in performance, Canada's growth accelerated from 1.5% in 2006Q4, while the U.S. economy decelerated from 2.5%. This is not just outperformance, but divergence.
Economic growth comes from five sources: consumer spending, investment by companies, government spending, international trade and inventory accumulation. The latter is the least obvious. When a company is short of inventory, perhaps because sales have been unexpectedly brisk, it can step up production to rebuild its stock. Even though the new production is not yet sold, it contributes to GDP growth through the inventory effect. It is of course quite possible that an inventory increase is unintended – that a period of slow sales sees inventory piling up in the back room, which also adds to GDP growth. What this means is that inventory swings can make it harder to interpret GDP data, especially around turning points in the economy.
Removing the inventory effect from GDP creates a measure of growth including only actual purchases, called “final sales”. It turns out that US companies were letting their inventories drop in the first quarter, while Canadian companies watched their inventories rise, and this difference contributed a lot to the perceived gap between the two economies. Final sales growth in the first quarter was 2.7% in Canada, a moderation from 5.0% in the preceding quarter, and 1.6% in the U.S., also a moderation, from 3.7%. Suddenly the difference in performance is not so large.
Trade effects can also cloud the picture, particularly since most of Canada's exports go to the US, where of course they are imports. Removing the effects of both inventories and trade from the GDP statistics provides an even clearer comparison, called "final domestic demand". These figures show first quarter growth of 3.1% in Canada, and 2.5% in the U.S., a very small difference. And, even more importantly, year-over-year trend growth of final domestic demand in both economies has been decelerating more or less in tandem since 2006Q1.
Accordingly, rather than decoupling or even diverging, the picture of our two domestic economies is more one of a synchronized slowdown with the U.S. leading the way. True, Canada’s trend domestic demand growth has been higher than America’s persistently since early 2001. But that simply means that the overall perception, that the U.S. economy has tended to outperform Canada, has been driven primarily by differences in international trade performance.
The bottom line? Canada rarely decouples significantly from the U.S. economy, and when it happens, it is usually quite temporary. Financial markets should reposition themselves over the next 6-12 months as the degree of economic synchronization becomes more evident.
Listen to the Weekly Commentary podcast.
Subscribe now to receive this commentary each week.The views expressed here are those of the author, and not necessarily of Export Development Canada.
