Study: The year in review: The revenge of the old economy

2005

Economic developments in Canada last year were again largely shaped by the global economy. This reflects the historic changes taking place as a result of globalization, notably the integration of Asia into the world economy.

Canada's economy is undergoing rapid and profound changes, and not just between booming resources and construction and declines in some manufacturing industries. The energy sector is developing new sources, while manufacturing itself was being buoyed by the strength in resources and investment demand. And all sectors have to deal with a shift in trade flows to Asia.

Any period of rapid change triggers fear, and last year was no different. The rising dollar raised widespread concerns about the erosion of our industrial base. Soaring energy prices recalled the economic slowdown triggered by the Organization of the Petroleum Exporting Countries (OPEC) price hikes in the 1970s. The spread of avian flu to many parts of the world resonated strongly with Canadians, after the SARS outbreak in 2003.

So far, none of these worries have been justified. Despite dislocations in some sectors, Canada overall rode a wave of prosperity to a 30-year low in unemployment, record equity and housing prices, and rising government and trade surpluses. This was especially true in Western Canada, which was uniquely positioned to profit from its resources and its geographic proximity to the United States and China.

Prices in commodity markets rose sharply for a third straight year, initially led by energy and more recently by mining products. These increases were reflected in higher stock market prices and the exchange rate. This encouraged more investment, which late last year passed household spending as the engine of growth.

Not all sectors profited equally from these changes. Some manufacturers were squeezed by the combination of soaring input costs and the rising loonie, notably forestry and clothing.

But overall, 62% of industries boosted output last year, little changed from 64% in 2004 and above its long-term average of 59%. As a result, the economy was increasingly pushing against its capacity limits, especially in Western Canada.

Some trends remained unchanged. Inflation stayed low, keeping interest rates near their historic lows. And old habits were hard to break: Canadians continued to buy trucks and sport utility vehicles in increasing numbers, and energy consumption grew despite high prices.

Energy dominates major trends, but it also is changing rapidly

The energy sector dominated most economic trends. Energy exports single-handedly lifted the trade surplus to a record high. Armed with bulging profits and attracted by bright prospects, energy companies again drove the upturn in business investment. Corporate income taxes and royalties from energy buoyed government surpluses. Energy was also behind the pre-eminence of the West in regional growth.

The face of the energy industry itself is changing rapidly. Conventional supplies of oil and gas are dwindling, especially as conventional fields in the West yielded less output in 2004 and 2005. Instead, producers shifted to offshore and non-conventional supplies.

This has been most evident in oil, where the oilsands now account for 42% of all domestic oil output. At $9.8 billion, investment in the oilsands jumped 55% last year.

Natural gas production too is moving to non-conventional sources. All of the increase in output since 2004 has come from coal-based methane, as conventional supplies have begun to dwindle. Investment intentions for coal gas hit $1.3 billion for 2006.

These new sources require large investments to carry and process oil and gas, implying energy will dominate investment for years. Already, the rapid development of the oilsands has created the need for new pipeline capacity, with investment plans up 83% for 2006.

The acceleration of business investment over the last three years has played an important role in the continuing growth of manufacturing, despite the rapid rise in the loonie. Shipments of investment-related industries have grown by 17% since 2002, the fastest gains outside of petroleum and metals.

Mining and transportation also surge

The boom in oil and gas spread to other sectors. Prices for a wide range of metals hit record highs. Non-metallic minerals also shared in the wealth, reflecting renewed interest in uranium and potash and the continued development of diamond fields in Canada's north.

Mining jobs rebounded 16% last year, while investment in mining jumped 20%. Non-metallic minerals led the increase, especially potash and diamonds.

A spin-off of increased demand for commodity exports was a rebound in transportation. Rail and water were particularly strong due to the transport of commodities. The West Coast also saw shipping increase rapidly as imports from China grew. In addition, air transport completed its recovery from the post-9/11 downturn in international travel.

Nowhere was the pre-eminence of the oil and gas, mining and transportation industries more evident than in profits. The operating profits of these industries soared by $16.2 billion last year, 80% of all profit growth.

Flush with cash, it is not surprising that these three industries led investment growth, with double-digit gains in 2004 and 2005 expected to continue this year. Together, they account for 35% of all business investment plans in 2006.

The increase in total corporate profits owes much to dealings with the rest of the world. Rising export prices added $12 billion to corporate coffers, equivalent to over half of profit growth last year. Firms also continued to benefit from lower import prices. An 11.8% drop in prices for machinery and equipment since 2002, mostly due to a stronger dollar, has saved firms over $10 billion.

Are resources more prone to the boom-bust cycle?

The growth of the resource sector has revived fears that the current boom will quickly revert to the bust of previous cycles (notably for energy). However, solid arguments can be made that prices will stay "stronger for longer."

The current boom is rooted in the integration of Asia into the global economy. Previous jumps in energy prices were driven by cuts to supply, whereas the current surge was driven by continued strong demand. High prices also reflect that major oil discoveries are occurring only in expensive locations, such as offshore or the oilsands.

The recent boom-bust cycles for oil and gas have been no more severe than for other sectors of the economy. Indeed, the spectacular bubble and subsequent train wreck for information and communications technologies manufacturing at the turn of the millennium is now the standard for instability against which all cycles are measured.

The auto sector has also had more severe cycles in output in the last three decades. The average cycles for housing were even more wrenching. By comparison, the cyclical ups and downs in oil and gas drilling (by far the most volatile part of the energy sector) were smaller on average.

Households are not too affected by higher energy bills

Meanwhile, consumers were surprisingly unaffected by the hike in energy costs. Energy bills as a share of household income rose only slightly, from 6.2% in 2004 to 6.7% in 2005, mostly due to gasoline. The relatively small increase reflects only modest hikes for electricity, which cushioned the impact on heating bills from the jump for oil and gas. As well, it also reflects a further pickup in incomes.

Despite higher energy prices, Canadians showed little drive to become more energy efficient. Gasoline consumption last year was essentially unchanged, despite the 13% spike in prices. Meanwhile, overall vehicle sales rose for the first time in three years.

While Americans did reverse their 25 year-long trend to buying more trucks (which include vans and sport utility vehicles) than cars, Canadians refused to change their buying patterns: trucks accounted for 48.2% of vehicle sales last year, up from 47.9% the year before.

The resilience of demand for trucks was led by Alberta, where they accounted for a record two-thirds of all sales. Still, the share of trucks actually edged up elsewhere, notably in British Columbia and Ontario, to 45.7% at the national level.

Growth tilted to the West

One of the most striking features of last year's growth was its concentration in Alberta and British Columbia, led by investment and exports. This raised employment and incomes.

Not surprisingly, retail sales in these two provinces dominated the national increase, contributing 38% of the overall gain. Housing starts in Alberta and British Columbia also outperformed the national average by a wide margin.

While other regions did not benefit as much from the resource and investment boom as Alberta and British Columbia, they did fare well in their own right. Quebec's unemployment hit a 30-year low of 8.3%, thanks to more jobs in construction and business services and a lower participation rate.

Ontario managed a respectable 1.3% gain in employment, with increases in construction and services outweighing losses in its industrial base. As a result, unemployment in Ontario was less than a point above its record low of 5.8% set in 2000.

Manufacturers in Ontario have benefited from rising investment demand. Indeed, a large majority of Ontario's manufactures (13 out of 16), outside of clothing, textiles and leather, posted higher shipments last year. Capital goods have risen nearly 10% since 2002.

Falling import prices save each household $300

Consumer price inflation remained low last year despite the surge in energy prices, an unprecedented phenomenon.

The restraint in prices originated in lower prices for goods with a large import content. A rising Canadian dollar and low-cost imports from Asia drove down the cost of goods such as clothing, household appliances and electronics.

Since 2003, prices for durable and semi-durable goods have fallen by 2.6% and 1.4% respectively. These lower prices saved consumers $3.5 billion on purchases of these items — equivalent to $294 for every household in Canada. This bonus of almost $300 per household is as much a symbol of Canada's prosperity from its rising terms of trade as the $400 cheques sent to every adult in Alberta epitomized its oil and gas wealth.

The participation rate contracts

The participation rate shrank last year, the first time it has contracted outside of a recession, despite low unemployment and rising wages. The decline was led by youths aged 15 to 24 years and adult women. For adult women, this is a notable break from decades of sustained increases.

The drop was concentrated in British Columbia and Alberta, falling almost two full points in both provinces, despite their tight labour market conditions. One explanation could be that incomes are so high that households no longer need two paycheques. Another is that child care coverage in Alberta is the lowest in Canada. Clearly, lack of demand is not the problem: the unemployment rate for these women is at a record low in both provinces.

The study "The year in review: The revenge of the old economy" is now available for free online. The study is also included in the April 2006 Internet edition of Canadian Economic Observer, Vol. 19, no. 4 (11-010-XIB, $19/$182), which is now available. The monthly paper version of Canadian Economic Observer, Vol. 19, no. 4 (11-010-XPB, $25/$243) will be available on April 20. This issue also presents another feature article entitled "Recent trends in corporate finance."

For more information, or to enquire about the concepts, methods or data quality of this release, contact Philip Cross (613-951-9162; ceo@statcan.gc.ca), Current Economic Analysis Group.