RECENT TRENDS IN SPENDING AND SAVINGS IN CANADA AND THE US

by F. Roy*

For a number of years, our economy has grown more vigorously than that of the United States, with the gap widening recently for a range of indicators–from aggregate demand to the labour market. Real GDP per capita has grown more in Canada in the last five years, reflecting both faster gains in GDP here and more rapid population growth in the US. For the first time in two decades, a larger percentage of Canadians than Americans held a job. Our unemployment rate remained higher, as a greater proportion of our working-age population was in the labour force than in the US.

This note focuses on differences in the spending and financial behaviour of the four major sectors of these two economies: households, government, business and external. The goal is to highlight some of the reasons for our improved performance by tracing their origin back to recent structural differences between these sectors, not to offer an exhaustive list of all the factors contributing to this gap. Briefly, this paper shows that spending in all non-government sectors has recently been stronger in Canada than in the US. Moreover, the public, corporate and external sectors are all running financial surpluses in Canada, while these sectors are all in deficit in the US. The counterpart of large current account surpluses in Canada and deficits in the US is large net borrowing by non-residents from Canada and lending to the US.

It is worth remembering that, while recently outperforming the US, Canada had ground to make up. The recession early in the 1990s was much more pronounced here–the year-over-year change in per capita real GDP fell for 12 straight quarters starting early in 1990, with the largest drop (-4.7%) in the first quarter of 1991. In the US, it fell in only five quarters, touching a low of a 2.5% drop during the Gulf war in 1991. However, since 1997, real per capita GDP in Canada has consistently grown faster than the US (Figure 1). This gap emerged in most sectors of the economy, reflecting differing attitudes to consumer spending and saving, investment outlays by firms and government fiscal policy. The most striking difference was in the external sector where this divergence in domestic demand was further magnified by opposing trends in the exchange rate.

Figure 1

Households

While overall household spending on consumer products and housing followed a similar track in the two countries, the composition varied. After 1997, households in Canada spent relatively more on housing, while those in the US spent more on consumer goods and services (this also has important multiplier effects for other sectors, as housing has the lowest leakage to imports). Over the last 4 years, the growth of housing totalled 33% in Canada, versus 13% in the US. Consumer spending on the other hand was up 16% in the US versus 14% here.

Underpinning these trends in spending was a marked divergence in incomes and savings. Consumer spending in Canada was fed by the growth of disposable income since 1998, reinforced by income tax cuts early this decade. The personal savings rate was steady at about 5%, while debt rose less rapidly than in the US. Canadian mortgage and consumer credit debt as a percentage of disposable income rose steadily by about 20 points in the 1990s to 99.0 in 2002. Heavy investment in housing meant that households overall were net borrowers over the last year, despite the positive savings rate.

Consumer spending in the US, however, was supported by a drop in personal savings (from 5% in 1998 to a low of just over 2% of disposable incomes by 2001) and an acceleration in debt loads. A number of factors encouraged households in the US to reduce savings more than in Canada, notably the wealth effect from having more assets in the stock market boom up to 2000 and a rising exchange rate, which helped to lower the price of consumer durable goods by nearly 9% since 1998 (versus a 1% dip here in Canada). The sharpest tax drop in 50 years early in 2002 gave a temporary lift to incomes, helping to boost spending and re-build savings back nearly to Canada’s level, although by late in the year this stimulus had begun to wear off. Less savings and lower taxes helped offset a weaker underlying trend of personal income growth compared with Canada, reflecting their less robust labour market. This also followed a loss of nearly $80 billion in equity wealth by American households in 2001 following the stock market crash. Meanwhile, household debt as a percent of disposable income rose nearly 30 points since 1992, including a jump from 104.4 to 122.4 in just the last four years.

Figure 2

Business

Firms in the two countries also behaved differently, to Canada’s advantage. The share of nominal GDP devoted to business investment was larger in Canada since 1997 and the gap grew after 2001. (Figure 3). This held true despite the surge in US spending on machinery and equipment at the peak of the technology boom, which lifted its portion of nominal GDP from 7.2% in mid-1992 to 9.8% in the second quarter of 2000, before the bust on both sides of the border. Canada benefited from the much larger role played by non-residential structures, nearly 5% of GDP, driven by the energy sector. Utilities and oil and gas reached 40% of all such investment in Canada during the 1990s, rising to over half by 2002, while they remained below 30% of outlays for non-residential structures in the US. Overall, the 2.6% of US GDP devoted to structures last year was the lowest since 1945 (when it was 1.5%, as the war effort consumed most output), reflecting their glut of unused plant and office space.

Figure 3

Firms in Canada were better positioned to spend relatively more because of much stronger earnings. (Figure 4). Coming out of the severe recession here in the early 1990s, corporate profits before taxes tripled in Canada over the past decade, versus a 66% gain in the US, with much of this gap originating in manufacturing (compared with 1988, the gap is only 93% versus 74%, a measure of the severity of our slump in the early 1990s). The gap widened recently, as profits held steady here over the last three years, while recession eroded them in the US.

Figure 4

Another measure of the buoyancy of profits in Canada: firms here were large net lenders in the last two years, despite the relative strength of spending, while in the US they continued to borrow even as they slashed outlays. Overall, firms in Canada had a surplus equivalent to 2.1% of GDP, the largest amount on record back to 1961. The corporate sector typically was a net lender in the 1990s, a reversal from the previous three decades when it was almost always a net borrower. In the US, companies remained net borrowers throughout the 1990s and into 2002, partly because they issued debt and retired equity (the opposite of Canada).

The greater willingness of firms to spend on investment in Canada was reflected in more jobs. The recent divergence in employment originated largely in a much smaller drop in Canada for jobs in the manufacture of industrial machinery and electronic products after the surge in ICT investment faded.¹ This partly reflects the better performance of profits and capacity utilization in Canada, especially in manufacturing.

Government

Public spending slowed in both Canada and the US throughout the 1990s, reinforced by lower interest rates since 1996. All government spending (including interest payments) relative to GDP in Canada fell 12 percentage points from its peak of 52.1% in 1992 to 39.8% in 2002. Over the same period in the US, it eased from 32.4% to 29.9% (Figure 5). Two-thirds of the dip in the US reflected lower interest payments on debt, while in Canada two-thirds of a much larger drop originated in lower program spending. Program spending (all governments outlays excluding interest payments) in Canada fell from 42.8% to 34.0% of GDP over the last decade, while it dipped 3 points in the US before recovering in the last two years to 28.0%. Provinces and the federal government led these cuts in Canada.

Figure 5

Government revenues remained stable in Canada and the US through the 1990s, even as spending fell. In Canada, however, they then declined from 44% of GDP in 1998 to 41.4% in 2002, largely due to income taxes, which, as a share of our GDP, fell to their lowest level since 1986. This drop reflected cuts to tax rates, as the tax base itself was swollen by more jobs. Tax collections by local government continued to grow, but not enough to meet the growing demand for services, resulting in their third-largest deficit since data began in 1961. Personal income taxes last year fell 14% in the US, due to lower rates, fewer jobs and falling stock prices, after levelling off in 2001.

After moving to a surplus in the 1990s, the trend of the budget balance was also different in Canada and the US from 2000 to 2002. Altogether, US governments shifted from a surplus equal to about 1% of GDP to a deficit of over 3%, while governments in Canada maintained a surplus of about 1%. In the US, government current and capital spending accelerated over the last two years to a 16-year high of 4.4% last year, led by a 9.3% surge in the volume of defence spending fuelled by the war on terrorism. Defense spending had fallen steadily in the 1990s, the peace dividend from the end of the cold war.

The better fiscal position in Canada also reflects the reduction of debt levels since the mid-1990s, when part of every federal surplus was devoted to paying off past debt. Most provinces also acted to reduce their debt load. From 1997 to 2001, government debt outstanding in Canada fell nearly $100 billion (or 12%), while it was unchanged in the US (servicing their debt, however, cost less as interest rates tumbled).

External

The US current account deficit ballooned from nearly zero in 1991 (when the US received large transfers to pay for the Gulf war) to $204 billion in 1998 to $503 billion in 2002, equal to 5% of GDP. On top of a rising exchange rate, the structure of domestic spending in the US was more favourable for imports than in Canada. Almost half the US external deficit originated in surging demand for consumer goods, with the rest about equally distributed between energy products and autos. Conversely, Canada’s surplus in trade in goods with the US trended up after the implementation of the Free Trade Agreement in January 1989, with the surplus rising to over 8% of GDP from 2000 to 2002. While US exports stagnated after 1999, ours grew by a further one-quarter. For the whole decade, Canadian exports and imports rose for every major commodity group, a sign of our greater integration into the world economy which positioned us to reap the benefits of trade through specialisation.

The US deficit with the rest of the world reached a record high of $432 billion. Along with China, Canada profited the most from American demand for imports. By comparison, at the start of the 1990s Canadian and Japanese exports to the US were about the same: by 2002, our exports to the US were nearly twice as large, and the largest of any nation. Mexico also benefited from the increased US propensity to import, to become the third largest exporter to the US in 2002 after China. Mexico increased its exports to the US, especially in the auto sector, which now ranks behind only their exports of machinery and equipment. Its auto exports soared from the equivalent of 10% of Canada’s in 1990 to 37% in 1998 and 52% in 2001, when Mexico’s auto exports rose even as Canada’s fell 10%.² Japan is now the fourth largest exporter to the US.

China is closing in on Canada for first place among exporters to the US. US imports from China rose rapidly, bypassing Japan from third overall in 1990 to second in 2002. In 2002 alone, China’s exports to the US surged almost 15%, while US shipments to China rose only 4%.³ This widening trade gap has persisted since 1997, leaving China with the largest share of the US trade deficit, nearly one-quarter in 2002.

Figure 6

Summary

Figure 7 summarizes the financial balances of the public, private (total household and corporate) and external sectors in Canada and the United States.⁴ It shows the upturn in the financial surplus of all three sectors in Canada by the end of the 1990s.⁵ Conversely, two of the three sectors in the US were running deficits. The US current account deficit continued to rise to record levels. The largest turnaround was for government, which, after a brief spate of surpluses, started to run deficits comparable to the mid-1990s at nearly 4% of GDP. Overall, their private sector returned to a net lending position, as a sharp increase in corporate borrowing was offset by an acceleration in household lending. These trends have begun to be reflected in the relative performance of GDP, with Canada were out-performing the US since 1997 due to stronger demand in all non-government sectors.

Figure 7a

Figure 7b

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Notes

* Current Analysis (613) 951-3627 or e-mail at ceo@statcan.ca.
1 See G. Bowlby, “The labour market: Up north, down south.” Canadian Economic Observer (Catalogue 11-010-XPB), January 2003.
2 Canada’s auto sector has generally not fared well in recent years in the US market. After 1998, American auto imports have doubled from South Korea and risen 32% from Mexico, 25% from the European Union, 19% from Japan, but fell 7% from Canada.
3 American imports from China were concentrated in computers, printers and other office equipment. US exports to China were driven by machinery, aircraft, medical supplies and plastics. Aircraft were the fastest-growing export to China, a measure of the speed of its development. China, while accounting for only 4% of global output, contributed 17% of global growth last year.
4 US data show a deficit for the overall private sector (as seen recently in The Financial Times, April 2, 2003, p.13 and in “The Perfect Fiscal Storm” by L.R. Wray, p.59 in Challenge, Jan.-Feb 2003). In this paper, we adapt the US data to Canadian concepts by excluding consumer durables, which results in a small surplus.
5 Net lending in the economy is always zero as financial surpluses in one sector are loaned to other sectors. In Canada, the net lending by the private and public sectors is offset by net borrowing by non-residents, as Canada lends its current account surplus to the rest of the world. In the US, non-residents lend large amounts to domestic borrowers.