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Study: Real gross domestic product and the purchasing power of provincial output

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The Daily


Tuesday, July 24, 2007

Rising commodity prices and the surging Canadian dollar have led to a divergence between real earnings growth and the increase in the purchasing power of those earnings, according to a new study. From 2002 to 2005, real earnings (real gross domestic product) rose by 8.3%, while the purchasing power of those earnings (real gross domestic income) increased by 13.4%.

The study found that high commodity prices and the rising value of the Canadian dollar against the American dollar have led to significant increases in so-called "trading gains" for many provinces, as well as the nation.

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The current boom in commodity prices, initially sparked by a surge in the energy sector, is now entering its fifth year. A wide range of commodity prices, from coal to uranium, have been affected, as has the Canadian dollar, which appreciated significantly after 2003.

The study noted that as Canada commits more of its resources to production, the volume of goods available to Canadians rises and economic output, as measured by real gross domestic product (GDP), expands.


Note to readers

This release is based on a research paper that examines the impact of price changes in imports and exports on economic welfare in Canada, and in each of the provinces.

The research paper examines how shifts in terms of trade and fluctuations in the ratio of prices of traded to non-traded goods affect the purchasing power of domestic production.

It also examines the evolution of real gross domestic product (GDP) and real gross domestic income (GDI) from 1981 to 2005 nationally and in the provinces.

The difference between real GDI and real GDP originates in how exports and imports are treated. Real GDP deflates imports and exports separately, while real GDI as measured in this release deflates net exports by final domestic demand prices. Importantly, real GDP and real GDI are not adjusted for financial flows.

Real GDP and real GDI focus only on the income earned and its purchasing power within a country or province. There is no adjustment for earnings that are repatriated to other jurisdictions, which may be important for understanding the evolution of income growth in some cases.


Canada sells exports to buy imports. When the price of exports rises or the price of imports falls, it allows Canada to import more goods without having to export more raw materials.

This is referred to as a "trading gain," which is not captured by real GDP. The study uses an alternative measure called real gross domestic income (GDI) instead. Real GDI responds to changes in domestic production and changes in trading gains.

The difference between the two measures is significant. Real GDP is a measure of how much Canada earns through domestic production. On the other hand, real GDI is a measure of the goods and services that income can buy.

The study found that from 2002 to 2005, real GDP increased by 8.3%, while real gross domestic income rose by 13.4%. Trading gains added 5.1 percentage points of growth, meaning that for every $2 of extra income earned by Canada, roughly $3 extra worth of goods and services could be purchased.

"Terms of trade": Price of exports relative to price of imports

An important ratio for determining how changes in export and import prices will affect Canada is the "terms of trade." This is the price of exports relative to the price of imports.

When the ratio rises, it indicates that the value of Canada's exports is increasing. In other words, exports should purchase more imports than they would have previously. A rise in the terms of trade, therefore, indicates that trading gains are increasing, and that the quantity of goods and services that Canada can purchase with its earnings is rising.

Canada's terms of trade are primarily determined by three factors: commodity prices, the exchange rate with the American dollar, and the prices of imported manufactured goods.

The terms of trade for the provinces are also affected by the same three factors. However, resources and industries are not equally distributed across the country. Therefore, some provinces can be more susceptible to shifts in the overall terms of trade.

From 2002 to 2005, shifts in terms of trade affected real income growth in all provinces. The two provinces that were affected the most were Alberta and Newfoundland and Labrador.

Surging energy prices between 2002 and 2005 led to terms-of-trade growth in energy-exporting provinces. In Alberta and Newfoundland and Labrador, the terms-of-trade growth led to large trading gains.

During this period, real GDI in Alberta increased by 38.0%, triple the growth in real GDP. Similarly, in Newfoundland and Labrador, real GDI expanded by 23.2%, which was roughly four times its real GDP growth.

As a result, an extra dollar earned between 2002 and 2005 bought roughly $3 extra of goods and services in Alberta, and $4 extra of goods and services in Newfoundland and Labrador.

Energy-exporting provinces have experienced the largest gains. However, the impact of rising commodity prices, the appreciation of the Canadian dollar and falling prices for manufactured components have also led to improvements in the terms of trade in most of the other provinces.

Impact of commodity prices varies over time

The study illustrates how the impact of commodity prices on real income in Canada varies over time and from province to province.

Sources of growth in commodity price indexes are not constant over time. As a result, the specific commodities driving the change suggest that the impact will be different from one province to the next.

The differing impact among the provinces is important for understanding the progress of real income in Canada. Before 2002, changes in terms of trade that benefited real GDI growth in energy-importing provinces had hindered real GDI growth in energy-exporting provinces. For example, during the early 1980s, falling energy prices had inhibited real income growth in Alberta and Saskatchewan, while bolstering it in the rest of the country. The regional differences offset each other so that real GDI and real GDP growth for Canada were roughly equal.

However, the recent surge in energy prices has been accompanied by a widespread increase in provincial terms of trade resulting from the appreciation of the Canadian dollar and the higher prices of all commodities. Consequently, the terms of trade have improved in most energy-importing provinces.

The effect of higher commodity prices and the appreciation of the Canadian dollar can be illustrated by events in three provinces: Newfoundland and Labrador, Ontario and Alberta.

In the early 1980s, Newfoundland and Labrador was an energy importer. Following the development of offshore oil and gas deposits in the 1990s, the province became an energy exporter. As a result, Newfoundland and Labrador's trading gains increased sharply as energy prices increased after 2002.

In Ontario, the 1986 energy price collapse made an important contribution to an improvement in the province's terms of trade and trading gains. In 1986, real GDP increased by 4.1% while real GDI rose by 5.6%. After 1986, rising prices for commodities other than energy continued to bolster increases in trading gains until 1990.

From 1998 to 2001, the terms of trade declined in Ontario as the Canadian dollar depreciated and energy prices rose. The 55.8% rise in energy prices in 2000 led to the biggest terms-of-trade drop in this period. In 2000, real GDP rose 5.9%, but real GDI only rose 5.2%.

From 2002 to 2005, however, gains in the prices of commodities other than energy and the appreciation of the Canadian dollar helped push up trading gains in Ontario, despite continued increases in energy prices. During this period, real GDP rose 7.5% and real GDI rose 7.7%.

Among the provinces, Alberta is the most susceptible to changes in energy prices. In 1986, the decline in energy prices led to a 15.7% decrease in real GDI through trading gains in Alberta. Real GDP fell 2.3%.

But after 1998, a series of improvements in the terms of trade, precipitated by rising energy prices, contributed to trading gains that increased growth in real income.

As a result, from 2002 to 2005, the growth of real income in Alberta was three times that of real GDP growth.

The research paper "Real GDP and the purchasing power of provincial output" is now available as part of the Economic Analysis Research Paper Series (11F0027MIE2007046, free), from the Publications module of our website.

More studies related to international trade are available in the analytical series Update on Economic Analysis (11-623-XIE, free) on our website.

For more information, or to enquire about the concepts, methods or data quality of this release, contact John R. Baldwin (613-951-8588) or Ryan Macdonald (613-951-5687), Micro-economic Analysis Division.