Strong Fundamentals Should See Canada Lead G-7 Economies

Strong commodity demand, comparatively low government and corporate debt along with favourable demographics should see Canada’s economic prospects lead those of the G-7 nations for much of the next decade, finds a new report from CIBC World Markets Inc.

The report notes that eurozone debt woes, along with geopolitical tensions in Asia, have, not surprisingly, grabbed the attention of the investor world recently. These concerns have overshadowed the strong longer-term fundamentals of Canada’s economy that could see the second decade of the 21st century be this country’s time to shine.

“Canada’s resource endowments, resilient financial system and favourable demographics relative to other G-7 nations make it an economic contender looking out over the next 5-10 years,” says Avery Shenfeld, Chief Economist at CIBC. “Another notable positive is in the healthier state of public and corporate sector balance sheets.

“These factors are no iron-clad recipe for national success in the near term, but do mean Canada is better-positioned than many of its competitors to deal with the challenges of the upcoming teen years. And where economic growth goes, corporate earnings, dividends and other rewards for investors are likely to follow.”

Mr. Shenfeld agrees with research that says economic rebounds from recessions linked to financial crises face greater headwinds than typical up-cycles. Government debt and the need to tighten fiscal policy in the aftermath of crisis rescue efforts appear to be the key transmission mechanism for this relationship. The research shows that countries that have higher indebtedness typically have slower rates of real per capita growth in the five years following the recession.

Given this, Canada is well positioned to outpace the typical major industrialized economy in the next few years, having less gross debt, and much less net debt, than most other nations. He notes that while an earlier rate hike cycle could prevent such a growth differential from showing through in 2010-11, Canada will have a longer-term advantage of dealing with a much lighter burden from fiscal restraint. Canada’s current federal deficit of three per cent of GDP (or five per cent including the provinces) pales next to double-digit deficit-to-GDP ratios for national governments in the U.S. and the U.K. The result is that if each country aimed to stabilize its debt-to-GDP ratio at 45 per cent, Canada would require a retrenchment of less than three per cent of GDP, while others would need fiscal cuts several times larger.

“That doesn’t mean that Canada won’t see a huge fiscal drag in 2011 – we estimate that the swing from stimulus to restraint represents a two per cent of GDP headwind in that year,” says Mr. Shenfeld. “But thereafter, the pain will be much lighter here than elsewhere.”

He adds that Canada’s economic growth will be driven by medium-term trends in population and productivity. “Demographers here and elsewhere are concerned about an aging work force that will slow growth ahead, but Canada is still well positioned relative to other mature economies. Japan is already seeing labour force shrinkage, and is ill-positioned to attract immigrants given language barriers and cultural homogeneity in its existing population. Fueled by immigration to a multi-cultural society, Canada’s economically active population is still set to grow faster than that of the U.S. or Europe.

“Immigration also has a side benefit, in terms of helping Canada make inroads into some of the world’s faster growing developing-economy markets. Research across countries has identified that bilateral trade tends to be enhanced between countries in response to the movement of people from one to the other. Business and cultural ties to the home country can facilitate the movement of goods, a trend that appears evident in the Canadian data. Continued in-migration from East Asia and South Asia should help build Canada’s export prospects in these fast growing markets.”

Mr. Shenfeld also expects Canada’s economy will see an output boost in the coming years as Canadian businesses invest in productivity-enhancing capital equipment. He notes that corporate Canada is carrying less debt than its U.S. counterpart leaving it more room to finance those plans. Governments have also done their part to encourage such spending, with corporate tax rates headed below those in all of the nation’s major developed-economy competitors.

“Productivity, which focuses on the volume of goods produced per hour, doesn’t, moreover, tell the whole story in terms of income and wealth,” finds Mr. Shenfeld. “In the past decade, volume gains were supplemented by an improvement in the global market value of the goods that Canada sells to the rest of the world (particularly commodities) relative to what it imports (consumer goods).”

He adds that even including the setback from softer energy and metal prices during the recent global recession, those terms-of-trade gains accounted for about a third of Canada’s domestic income growth since 2002. That trend almost certainly has further to run given the rising needs of dynamic resource-hungry emerging markets.

“It was some 106 years ago that Wilfred Laurier opined that while the U.S. dominated the 19th century, the 20th century would belong to Canada. It didn’t, of course, quite work out that way, as forecasts with a 100-year horizon rarely pan out. But it might well be that, if not the 21st century as a whole, its second decade could be Canada’s to shine, at least among the industrialized economies of the West.”

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