New government faces growing global economic and political headwinds

Canada’s newly elected government (a Liberal minority) will have to grapple with increasing economic and political tensions, according to RSM Canada’s quarterly Real Economy report.

Although Canada’s real GDP hit an annualized 3.7% in Q2 2019, the less volatile year-over-year GDP metric has been declining since 2017, and was only 1.5% during April, May, and June.

RSM Canada’s most recent economic report points out that trade wars (US v. China) and geopolitical tensions (Brexit) are slowing the Canadian economy, launching ripple effects on global spending and growth.

Economic analysts have highlighted a slipping global economy, with China growing at its slowest rate in a decade, and Germany and the US already in the midst of a manufacturing recession.

The initial decline in business confidence among manufacturers arrived with the announcement of US tariffs in early 2018, while Brexit uncertainty further impacted the sector. Canada’s manufacturing sector, which makes up 10% of total industrial output, has a seen a downward trend in monthly real GDP since Q3 2018, according to the RSM report.

Canada’s commodity and energy markets are also dipping – a sizable issue because resource extraction accounts for 7.8% of GDP and agriculture accounts for 2.1%.

Commodity prices crashed in the 2007-2009 financial crisis, and then again during the 2015 oil price shock. Demand for Canadian energy started to decline again in 2018 with US tariffs pulling down global growth, and production of Canadian crude oil and agricultural exports has likewise decreased since May 2018.  

The RSM report notes that either buyer demand for Canadian resource exports has declined, or buyers have found other (more attractive) sellers – but in either case, commodity prices would further plummet amidst slowing global growth.

RSM Canada’s Financial Conditions Index – which is a composite of stress factors in the country’s equity, bond, commodity, and money markets – has indicated increased levels of risk in each of the markets since Q2 2018, with the greatest stress in commodities. Financial market stress is linked to the willingness of borrowers and lenders to take on additional risk, which is critical to economic growth.

The report highlighted that since its peak in 2014, Canada’s investment growth has been decelerating – falling across all categories (business investment, nonresidential structures, machinery and equipment, and intellectual property) except for, unsurprisingly, residential structures.

RSM notes that monetary policy is constrained, and further decreasing already low interest rates would likely further spur on the housing bubble and household debt. As such, fiscal spending on infrastructure and education might be a wise move, creating positive impacts on productivity, intellectual capital, and potential output.

Joe Brusuelas, chief economist with RSM US LLP, said, "The country is grappling with a worldwide slowdown, all facilitated by geopolitical tensions and trade wars, and the implications are hitting Canada's most prominent industries hard. It's vital that the incoming government implements the right measures to get the country back on its feet, providing a well-needed boost to infrastructure, businesses, and communities."

The Liberals ran a deficit of $14.9 billion in 2018-19, and project a deficit of $27.4 billion in next fiscal year, decreasing to $21 billion in 2023-24. The report states that neither the Liberals nor Conservatives plan to eliminate the deficit in the short term, though the Conservatives said they would do so over the next five years.

Four major measures can give the economy a boost in the event of a downturn: adjustments to employment insurance, individual tax relief, business tax incentives, and government spending (such as on infrastructure projects).

Tax cuts, credits, and rebates for lower- and middle-income households are the most effective from a multiplier perspective – or how much economic activity they induce – while infrastructure projects tend to be less effective in the short run, but have the potential to create long-term productivity benefits.

According to the report, the Trans Mountain pipeline project is a smart bet for short-term stimulus and long-term productivity, holding a potential GDP increase of $164 billion and 40,000 Canadian jobs – half of which would go to small- and medium-sized enterprises.

Alex Kotsopoulos, vice president of projects and economics at RSM Canada, said, "Our research shows that developing the pipeline project would not only increase Canada's GDP but, most importantly, it would support the backbone of Canada's economy – its small-to-medium-sized businesses – through job creation and community investment."