Overview of Canada Economy

1.  From Oil to AI: The Future of the Canadian Economy

The economy of Canada is traditionally focused on natural resources that are used in the North American manufacturing sector. Industries such as lumber and potash (manufactured salts that contain potassium) have historically been major sources of growth. The oil industry in the country took off as international oil prices rose to all-time levels during the mid-2000’s, making Canada’s vast “oil sands” economically viable and sparking a boom in bitumen mining and refining. Bitumen’s high cost of production and the high-density, high-sulfur content of its resulting oil product means that it trades at a discount, often significant, to WTI crude. This proved important in 2014 when oil prices tumbled, causing significant layoffs in the Canadian oil industry which had, by then, become a major employer in provinces such as Alberta. The oil shock caused the country itself to experience what some described as a mild recession. As a result, growth ground to a near-halt.

The oil shock exposed a long-standing vulnerability in the Canadian economy and underlined the need for Canada to diversify away from its reliance on industries that fluctuate based on the whims of the global economy. As such, Canada has worked hard to foster a startup culture in its tech sector and attract entrepreneurs into the country. The rise of Canada’s tech sector (discussed in our industry report) is buoyed by a highly-educated workforce, leading research in AI and machine learning, as well as accommodative immigration policies that fast-track the entry of skilled workers and experts into the country. Canada’s universities, with their place at the forefront of AI research, are churning out graduates and research that is fueling this tech boom. Many are making their way south of the border, which is stoking fears of brain drain. However, given the uncertain future of immigrant workers in the US, it is possible that Canada might be able to hold on to its talent and sustain the growth of its tech hubs.

2. Growth Sectors and their Variance Across Different Provinces

While the excitement surrounds Canada’s tech sector, it is still primarily a resource economy that relies on its traditional industries. Canada’s largest sectors are Real Estate, Manufacturing, Oil and Gas, and Finance and Insurance. Any shifts towards new industries will be slow in nature, even if it means a return of stagnation to the economy. Particularly, while global oil prices remain elevated from their 2015 levels, the price of Canadian oil is trading at a very steep discount to WTI prices with the West Canada Select trading reaching $16.71 on October 18 compared to WTI of $69.28. Due to the heavy nature of Canadian oil, there are limited refineries capable of processing it. Many of those that are capable of refining it (located in the American Midwest) are experiencing maintenance outages. Coupled with limited pipeline capacity, this has led to a supply glut pushing the price down. This is bad news for the Canadian economy as a whole, but particularly for provinces that are reliant on the energy industry. Affected by this glut are the provinces of Alberta and Saskatchewan, which in 2017 attributed 32.9% and 22.5% of their GDP to the energy sector.

Further weaknesses in the Canadian energy sector relate to its pipeline woes. Historically, the

Canadian oil industry had counted on the construction of Keystone XL to help deliver more oil to the US. However, following regulatory delays to that project Canadian companies looked for other outlets. The most prominent such outlet is the Trans Mountain Pipeline (TMP). The TMP is intended to be built from Edmonton to the Pacific coast of British Columbia, allowing an increase of the number of tankers that sail within the Burrard Inlet bordering Vancouver. The subject of a legal battle between the provinces of British Columbia and Alberta, the TMP was approved in 2016 and then had its approval squashed in October 2018 by the Supreme Court of Canada as it found that the federal government had not followed its own required procedures when approving the project. The delays with TMP have swung the hopes of the oil industry back to Keystone as the impediments related to the American regulatory approval have evaporated under the Trump administration. One thing is for certain: the reliance of Canada’s economic growth and future, especially that of Alberta (one of its largest provinces) make energy a significant risk to the future prosperity of the country.

In an effort to diversify its economy away from the volatile energy sector, Canada has pushed to attract high-skilled knowledge workers into its economy. The immigration system of the country had already been geared toward the quick approval of workers with job offers and those whose skills are deemed to be in high demand. With the recent clampdown on foreign workers in the US, particularly those applying for or holding H-1B visas, Canada suddenly seems much more attractive to employers and employees alike. Amid increased scrutiny and denial of foreign workers looking to move to the United States, Canada launched its Global Skills Strategy which allows foreign workers who qualify to obtain work permits in 2 weeks. By doing so, it hopes to attract international talent that it believes will be vital to the growth of its economy. Canada’s immigration system is a critical advantage to its burgeoning tech sector (discussed further in our industry report), and its growth is starting to be noticed globally. Its concentration in the cities of Toronto, Montreal, and Vancouver, however, is leading to concerns about how able those cities are to provide an affordable lifestyle to their newcomers. Especially in the case of Toronto and Vancouver, the still very high real estate prices are a very possible drag on the growth of new industries coming to the country.

However, this leaves the rest of the country in a bit of a bind. While growth is concentrated in a tech sector that is clearly at the global forefront, the rest of the country finds itself exposed not only in terms of its reliance on commodities but also on an industry that is slowly but surely going out of favour while being bogged down in regulatory concerns. While Canadian commodities are more than oil and gas (the country is one of the major producers of wheat in the world), the general attitude shaped by the oil price crash in 2014-2015 is moving away from reliance on industries where firms are price takers.

 3. What does the new USMCA deal mean for Canada?

Talking about Canada means necessarily addressing the relationship between the country and the United States. Trade between the two countries was a focus for President Trump during his campaign and after his election. However, after the signing of a “replacement NAFTA” deal on October 2nd, titled the United States-Mexico-Canada Agreement (USMCA), the outlook for North American trade doesn’t seem to be materially different. While there are certain aspects to the new deal that are different from its predecessor, the USMCA appears to be very similar to NAFTA. That said, it is important to note that the new agreement does not include the removal of the steel and aluminium tariffs that the two countries have imposed on each other recently. The US has not outlined a timeline for when those tariffs would be removed and as such Canada has not removed its retaliatory tariffs either.

Some of the highlights of the new deal are:

  • Increase in the regional content requirements for autos manufactured in North America. Under the NAFTA deal, 62.5% of the components of the autos manufactured in the member countries had to be sourced from North America itself. That has been increased to 75%. Furthermore, 40% of those components have to be manufactured by workers making US$16 per hour. This lessens the disadvantage that Canadian and America workers are under from low-cost overseas and Mexican workers. Finally, it guarantees that Canada is able to ship 2.6 million cars a year tariff-free (should any be imposed in the future).
  • The Canadian dairy, egg, and poultry industries are all under a supply management system that sets prices and stabilises supply. The system is responsible for the high relative prices of these commodities in Canada. This is how it works: a national marketing agency determines how much of a commodity should be produced in the country and in each province (through a quota system). There are 10 regional agencies that work in each of the provinces of the country to administrate the quota and act as the sole buyer of the commodity from the producers. This is then sold to the processors. Producers are guaranteed a minimum price. Finally, the producers are protected by tariffs to prevent outside competition. In the case of the dairy industry, no imports of outside milk are allowed. This has drawn the ire of the Trump administration. Under the new rules of the USMCA, US dairy producers are allowed access of up to 3.6% of the Canadian dairy market. This was touted by the Trump administration as a huge victory. However, considering the size of the access granted, it’s hard to consider this a victory at all. The supply management system remains largely intact with no further plans for deregulation, and no political party in Parliament is expected to support any further deregulation or access to American dairy workers. The fact that such a contentious issue ended up as being little changed from the past can only be described as baffling.
  • The dispute resolution mechanism between states, Chapter 19 of NAFTA, has been largely retained in the USMCA as Chapter 10. It allows the settlement of disputes between states through a neutral panel of judges. It also eliminates controversial investor-state dispute settlement (ISDS) mechanisms from disputes between Canada and the United States. ISDS mechanisms allow investors or corporations to sue governments for what they might perceive as unexpected changes in law that cause them to lose profits. The retention of Chapter 10 is considered a clear win for the Canadian government which insisted on its inclusion in the new deal. Prime Minister Trudeau underscored the vast importance of this provision to Canada by stating, “We know we have a president who doesn’t always follow the rules as they’re laid out”. Canada believes that by retaining a dispute resolution mechanism it can safeguard itself against what it might view as illegitimate trade practices by the US.
  • Copyrights were another key, though less publicised US issue. Canada agreed to US demands of bringing their copyright laws in line with those of the US and the EU, increasing the time limit of copyrights from 50 years after the creator’s death up to 70 years. Furthermore, Canada agreed to extend the protection timeline for biologic drugs. Biologic drugs are a new class of drugs manufactured through biotechnological techniques involving the manipulation of living cells. USMCA extends the timeline for protection of these drugs from generic competition from the previous 8 years to 10 years (which represents a compromise between the two parties as the US was aiming for 12 years). Those changes, especially the issue of copyright timelines, are the main US victory in the final deal, and are further protection for an economy where media is a significant industry and a massive point of strength to American soft power.
  • A seemingly minor point but one that speaks to American fears of how Canada will react to this spat of trade uncertainty is Chapter 32, section 10 “Non-Market Country FTA” which requires that any country negotiating FTA’s with non-member countries inform other USMCA members of any intentions to negotiate a trade agreement with outside countries, stipulates advance access to the text of any deal that will be agreed to, and allows other countries to leave the USMCA due to the signing of said trade agreement with a 6 month. This is clearly an American signal towards Canada and its aim to secure further trade ties with China. However, it is unclear how much of a deterrence this could be and what the aim of this clause is. NAFTA already had allowed members to leave the agreement, and the new USMCA has similar language already. The stipulation that the text of a potential agreement be shared 30 days after it is agreed to (when it is almost always public by then) further suggests that this clause has an element of signalling to Mexico and Canada that the US will look to further draw these countries into the American sphere of influence and be part of the broader US strategy to contain China.

While the changes of the USMCA may be minor, the resolution of some uncertainty associated with North American trade is a major boon for the Canadian economy. This is especially the case since the fears among many concerned parties was that the breakdown of talks between the negotiating parties would have severe repercussions for Canada. With this agreement in hand, Canada can breathe a little more easily as it looks to continue to move its economy towards a more diversified nature. The risks associated with commodity prices and trade remain elevated, but the country looks to set itself apart from other places to invest as it is at the forefront of cutting-edge advances in technology.

Source from: MERatings