Slowth: Welcome to the New Abnormal

May 1, 2016

Except from the May/June cover illustration by Luke Ramsey

Canada's economy has served up “serial disappointments” since 2012, as Bank of Canada Governor Stephen Poloz puts it. We are not alone. Forecasts for global growth have been continuously downgraded over the past four years. Current private sector estimates for Canada in 2016 range from 0.9% to 1.5%, essentially a stall. Forecasters are promising better years ahead, but with every new Department of Finance or International Monetary Fund assessment the economic turnaround gets pushed further into the future. 

Welcome to the New Abnormal. 

Slowth (my term for slow or no growth) is not going away anytime soon, and it is changing both our prospects and our politics. For the first time in a generation, a growing chorus of voices say it is time to reduce poverty and inequality. In response, most Canadian governments, at every level, have started to act. Never has it been more satisfying to say the words: better late than never. 

But even with increased political willingness to follow the crowd (rather than the lobbyists), redistribution gets harder to accomplish as the rate of growth declines. New policy initiatives are reduced to ever more challenging trade-offs in what increasingly looks like a zero-sum game. 

Let's be clear: slow growth need not be a bad thing, particularly when you consider that cleaning up after oil spills, selling arms to Saudi Arabia, and expanding state surveillance technology in response to unspecified terrorist threats will add to a country’s GDP. Slow growth can reflect new supply chains and technological improvements leading to cheaper costs of production and lower prices. 

Unfortunately, when it comes to a progressive agenda of public solutions to public problems, slow growth also means the public purse will shrink. 

One of the unavoidable drivers of slowth is population aging. Seniors have lower incomes and spend less money than the working-age population. As seniors make up a larger share of the population than ever before, we can expect that less income and sales tax will be collected. In other words, as the working-age population drops, we will have to tax ourselves more if we want to collectively do more. That has never been an easy sell.  

While many progressives turn to government as Option #1 when something needs fixing, we cannot ignore the health of the private sector. To put it another way, though growth may not be the only or best fix for inequality and poverty, the alternative (recession) only makes things worse. 

A fixation on balancing the books at this stage would almost certainly trigger a recession. But while a government willing to tax and spend can make a big difference, it's unlikely to spur the pace of growth in a $2-trillion economy in the near term. Simply put, government actions matter, but macroeconomic realities can swamp even the most progressive policies. 

Where the loonie fits in

This spring, I was asked to comment on these issues before a Senate committee on banking, trade and commerce. While much of the news lately considers the size of the federal budget or whether oil prices will pick up, my presentation looked at how a low Canadian dollar interacts with slow growth to make matters even more complicated.

The loonie was at par with the U.S. dollar when the 2008 crisis hit. Two-and-a-half years later, it had returned to this level, primarily reflecting a renewal of global demand for Canada’s natural resources, particularly oil. As oil prices plummeted last year and again early this year, the loonie tumbled in value against the U.S. dollar, unleashing a host of issues that are associated with slow growth, and eclipsing most effects of public policy. 

Why is the loonie so low? First, declining global demand, driven by the slowest growth in China in 25 years, is propelling a downward growth spiral as companies respond to slowing sales with further cuts to costs. Second, oil and commodity supply gluts continue to get bigger. Demand is rising for these products but at a slower rate than supply growth, which lowers commodity prices. Third, a relatively stronger U.S. economy has dulled some of the loonie's lustre. Unemployment south of the border is below 5% and the central bank raised the benchmark interest rate in December for the first time in almost a decade, triggering capital flight to the U.S.

Now, a low Canadian dollar has its benefits, and has triggered more economic activity in non-resource sectors than virtually any public policy in recent memory. Consider the following examples:

More exports: Things produced in Canadian dollars and sold in U.S. dollars (e.g., commodities like oil and beef, but also autos and services) will enjoy higher margins and profits. 

More U.S. consumers: The loonie currently offers almost 40% more purchasing power for Americans. Expect more tourists in Canadian vacation spots, at sports tournaments, or enjoying events like Pride and the Toronto International Film Festival. The low Canadian dollar reverses the direction of cross-border shopping, which strengthens retail and may lead to some repatriation of the capital that migrated south with the snowbirds (who purchased $92 billion in U.S. real estate from 2009 to 2015). 

Greater investment potential: A lower dollar means lower relative wages, so we can expect some U.S. businesses will produce more in Canada. Hollywood North expands when the exchange rate falls. The film industry was worth about $1.5B in Toronto alone in 2015, with foreign productions doubling since 2014. Advanced manufacturing is already seeing a boost (thanks to numerous innovation clusters throughout Canada). If the dollar stays low, reinvestments in our auto manufacturing facilities may be worth another look. 

Canadians import one-third of GDP, largely from the U.S. (China is in a very distant second place, accounting for 7% of Canada’s merchandise imports). A low-for-long loonie could trigger import substitution (i.e., investments that result in Canadians producing more of what they consume). On the other hand, a low dollar entails a number of serious economic negatives that can easily cascade, offsetting public policy efforts to boost growth. 

For one thing, with lower purchasing power, consumers are paying more for imports, notably food. Low-income households are hit the hardest, since fresh fruit and vegetables are mostly imported from the U.S. Businesses that import intermediate goods are paying more, too. The lower loonie is like a pay/profit cut.  

Slowing demand has also changed the retail landscape—think of the high-profile closures of Target, Future Shop and many smaller players. Expect more corporate consolidation as retailers struggle to absorb costs (instead of passing them on) to minimize falling sales. 

Stranded assets are another Canadian problem. Capital spending (capex) in oil and gas fell by more than 30% in 2015 compared to 2014 and is forecasted drop at least another 19% in 2016. Moody's estimates oil capex will fall 25% globally this year. Should demand continue to fall, up to $2 trillion in scheduled projects may become stranded assets. 

Finally, a lower dollar means bigger deficits.Government budgets are being pressured more directly by falling oil prices than the low dollar, but the two are intertwined regionally and nationally. 

Global forces at play

It is often said that markets don't like uncertainty—as if people do! Where the loonie lands has profound impacts on the restructuring of our industrial base and the health of the economy. Will the loonie stay low for long? Countervailing factors are at play.

For example, Iran is aiming to add one million barrels a day to global oil production in 2016, which will put further downward pressure on oil prices and the Canadian dollar. Globally, producers are already pumping 1.5–2 million barrels more a day than is being consumed. At over nine million barrels a day, U.S. production has not yet responded to lower prices. These factors mean the loonie stays lower for longer.  

A hard cap on Alberta’s greenhouse gas emissions and an international commitment to limit global temperature increases to 1.5 degrees Celsius will produce more aggressive policies to conserve and generate more energy from renewable sources. Europe’s environmental initiatives have resulted in 1.5% less demand a year, a plausible scenario for Canada. This too would put downward pressure on the value of the loonie. 

Upward pressure is also possible, however. We’re hearing about asset bubbles in China. Globally, corporations owe $29 trillion, with a third of companies failing to generate high enough returns on investment to cover their cost of funding. Tensions are escalating in the Middle East (now potentially between Turkey and Russia). The acceleration of any of these concerns could make the Canadian economy look like a safer bet, leading to an influx of capital. That would strengthen the dollar.  

Similarly, weaker than expected job growth in early 2016 forced the U.S. Federal Reserve to signal it may delay its plans to raise interest rates. If recent slowdowns in manufacturing activity continue, there is even a possibility that the December rate hike could be reversed. Ratification of the Trans-Pacific Partnership trade deal (TPP) could further slow U.S. manufacturing and job growth, making the Canadian economy look stronger relative to the U.S. than it otherwise would, and leading to a higher value for our dollar

Acknowledging these realities are beyond our control, what should be done? What can be done? 

First, we need to recognize that monetary policy has limited impact on the value of the loonie, and fiscal policy that stops short of a $30-billion deficit to finance stimulus for a couple of years can have little impact on a $2-trillion economy over the long term. Public policy that is truly concerned about slow growth—and putting Canada back on an expansionary path—must look past this year's GDP and deficit to develop long-term strategies for building future potential based on ecologically sustainable growth that delivers good jobs and good pay. It’s the kind of thinking that is beginning to take place at the highest levels of policy development.

Whether we figure out how to speed it up, or learn to adapt to it, slowth will challenge our way of thinking about the world and what makes it go round. It will force us to find ways to unlock its opportunities and to rethink how governments can be a catalyst to succeed in the New Abnormal. 

Armine Yalnizyan is a senior economist with the Canadian Centre for Policy Alternatives. Follow her on Twitter @armineyalnizyan.

This article was published in the May/June 2016 issue of The Monitor. Click here for more or to download the whole issue.