Canada: Waiting for the European Union Global Economic Outlook, Q4 2016

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In 2014, Canada and the European Union signed an ambitious trade agreement, CETA. Two years on, the treaty has yet to come into effect. What’s causing the hold-up?

Where are the exports?

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The decline in oil prices in late 2014 hit Canada hard. As a producer of the most expensive oil in the world, Canada was vulnerable.1 But Canadians might have expected the country’s diversified economy to provide some cushion. A large chunk of the Canadian economy is invested in manufacturing, not energy. When oil prices were hovering at 100 US dollars (USD) per barrel, Canadian manufacturers complained—not unreasonably—that oil was crowding out more employment-rich activities in Canada’s industrial heartland by raising the value of the Canadian dollar and making industrial exports uncompetitive.

When oil prices fell, the exchange rate behaved as expected (and as manufacturing-intensive Ontario and Quebec hoped). The Canadian dollar (CAD), plunged from CAD 1.07 per USD in mid-2014 to CAD 1.42 by January 2016 (although it has since come back to around CAD 1.30). That’s a hefty 32 percent increase in Canadian competitiveness right there. Initially, exports responded. Figure 1 shows that nonenergy export growth picked up to the 10 percent range, and exports of major industrial products grew at more than 20 percent for some time.2 Some of this growth is likely because much of this trade is invoiced in US dollars, so the same exports are worth more Canadian dollars. But real measures of Canadian exports showed strong growth as well. The growth of jobs and activity in Ontario and Quebec easily offset the loss of jobs in resource-heavy provinces, especially oil-rich Alberta.

Sometime early this year, however, things changed. As figure 1 shows, Canadian nonenergy export growth stopped in early 2016. Industrial exports were below their year-ago level in July. That’s not a good sign for the Canadian economy, and not what should be happening as long as oil prices remain soft. Without the continued shift to manufacturing exports, Canada faces a significant challenge in reaching and maintaining full employment.

Figure 1. Export growth
Without the continued shift to manufacturing exports, Canada faces a significant challenge in reaching and maintaining full employment.

Growth worries

Canada registered a 1.6 percent decline in GDP in Q2 2016.3 Statistics Canada pointed out that, excluding the impact of the Alberta wildfires, GDP growth would have been positive—but just barely.4 Q3 growth will likely show a significant rebound in Q3, but the underlying trend is a bit worrisome. Business investment has been soft recently, and exports have stopped contributing to growth as well. To some extent, that’s the result of recent US weakness. But the sudden slowdown in exports is more than might be explained by US growth dropping to the 1 percent range.

The labor market still appears a bit weak. While year-over-year job growth is slowing in the United States, it was 1.7 percent in September. Canada’s job growth, on the hand, grew to only 1.2 percent in June (when the latest payroll data were available; see figure 2). Canada’s 7.0 percent unemployment rate compares unfavorably with the United States’ 4.9 percent. The Canadian economy’s inability to create jobs is a matter of concern.

Figure 2. Lagging Canadian job growth

Not surprisingly, the Bank of Canada has kept interest rates on hold. The September statement suggested that there are reasons for optimism,5 but the direction of policy is clear: The Bank of Canada is waiting—and a big number for Q3 GDP won’t change that.

But, as the statement noted, Canadians have a significant reason to be optimistic. The bank expects the government’s infrastructure spending program to show up in economic data by the fourth quarter. That should help add some needed jobs and domestic demand. This autumn, the Canadian economy hopes for rescue—not by the Royal Canadian Mounted Police, but by Prime Minister Justin Trudeau’s embrace of Keynesian economics.6

This autumn, the Canadian economy hopes for rescue—not by the Royal Canadian Mounted Police, but by Prime Minister Justin Trudeau’s embrace of Keynesian economics.

Canada’s trade treaty with Europe: Further Brexit fallout?

In August 2014, Canada and the European Union signed an ambitious trade agreement, the Comprehensive Economic Trade Agreement (CETA). Two years later, the treaty has yet to come into effect. While the economic gains are likely to be modest, Canada’s experience with its most ambitious trade treaty since the North American Free Trade Agreement demonstrates how much the atmosphere surrounding such agreements has been poisoned by growing opposition to globalization and the rise of nationalistic political leaders in the European Union as well as in the United States (but, so far, not so much in Canada).

It also demonstrates that negotiating anything with the European Union is a difficult task. Negotiations started—and, in theory, ended—under the previous Canadian Conservative government. The Liberals—victors in the recent election—also supported the agreement, and the new government has adopted completing the treaty as a policy objective. As long as the treaty has the support of the government, final ratification by Canada is certain. Why, after more than two years, has the treaty not taken effect? That’s a story about the European Union, not Canada.

On the conclusion of the negotiations, the European Union required time for legal review and to translate the treaty into the European Union’s 23 official languages. As that happened, treaty opponents found their voices. Meanwhile, the overall mood in the developed world has turned against such agreements: The success of Brexit, the opposition of both US presidential candidates to the Transatlantic Trade and Investment Partnership (TTIP), and the success of Eurosceptic parties in many EU countries underline how little political support exists for increased globalization.

As is common these days, the key problems are not around tariffs on manufactured products, or even trade in agricultural products. Instead, the most controversial provisions involve intellectual property and the resolution of investment disputes. The exact nature of these issues is too complex to completely cover in this short essay.7 Broadly, the issues include protection for pharmaceutical patents, agreement on common rules for labeling agricultural products, and common standards for copyright protection. A further problem is the agreement for settling investment disputes. The European Union essentially reopened negotiations in January over this particular issue. Canadians have been tolerant about the delay so far, but the European Union’s inability to complete the agreement is likely getting a bit frustrating.

Why has the European Union been so finicky while negotiating with Canada? CETA may set parameters for the much more controversial TTIP agreement between the European Union and the United States. It’s a huge treaty between two of the largest economic entities in the world, and it’s not surprising that EU negotiators would be careful about letting CETA set precedents for TTIP.

Then came Brexit. Originally, the European Commission believed (and stated strongly) that the commission and the European Parliament could ratify the treaty for Europe. Many Europeans, especially those opposed to one or more of CETA’s provisions, have argued that the treaty must be ratified instead by parliaments in all 28 EU countries instead.8 These arguments were brushed off by the commission.

After Brexit, it became clear that the commission’s position was politically untenable. In July, the commission backed off, deciding to accept the treaty “provisionally” while sending it to member parliaments to be ratified. At the time of this writing, Canada and the European Union are planning a summit for October, to include a treaty-signing ceremony. However, despite Canadian optimism—Trade Minister Chrystia Freeland has promised to “press ahead” with implementation of the treaty9—opposition in Europe is gathering steam.10

Implementation of the treaty is not likely to have a huge impact on Canada’s economy. A joint study by the Canadian and EU authorities prior to the negotiations found that full liberalization of goods and services trade between the two countries would increase Canada’s GDP by about 0.8 percent and the European Union’s GDP by less than 0.1 percent.11 But even if the immediate impact is not huge, diversification of trade would be useful for the Canadian economy. Currently, about three-fourths of Canada’s exports go to the United States, and about two-thirds of the country’s imports come from the United States. Since the United States has been the most reliable driver of global growth in the past few years, Canadians have little reason to complain in the near term. But longer-term experience implies that Canada would benefit from closer relations with another major economy, such as the European Union. Unfortunately, despite the best efforts of Canada’s government, Brexit and Europe’s overall political problems may prevent this from happening in the near future.

Longer-term experience implies that Canada would benefit from closer relations with another major economy, such as the European Union.