11-010-XIB
Canadian Economic Observer
April 2006

The Year in Review: The Revenge of the Old Economy

by P. Cross*

Introduction

Economic conditions in Canada last year were again largely shaped by developments in the global economy. This reflects the historic changes taking place as a result of globalization, notably the integration of Asia into the world economy. This triggered a tectonic shift in relative prices in several markets starting in 2003 and continuing since. These changes were initiated by a surge in commodity prices, which hit another record high last year, led by energy and minerals.

Canada has been well positioned to profit from these changes over the last three years due to its large resource base. The surge in commodity prices and exports helped push the exchange rate up from US65 cents early in 2003 to 86 cents late last year, the most rapid currency shift in our history. The rising exchange rate and higher commodity prices improved our terms of trade (the ratio of export to import prices) for a third straight year. The resource boom also led the stock market to new highs, nearly double its low in 2003 after the dotcom bubble burst. The income earned from exports fuelled domestic spending, which accelerated for the third straight year.

Figure 1

In each of the last three years, these same events have dominated changes in the economy. The thriving energy and mining sectors have boosted exports and investment, helping to drive unemployment to 30-year lows, especially in western Canada. In turn, the rising dollar helped lower the cost of imported capital, even as the price of labour has risen. This encouraged more investment, which late last year passed household spending as the engine of growth. This investment will further boost labour productivity, which began to pull out of a prolonged slump when resources were being rapidly re-allocated from ICT sectors that were spearheading a shift to a ‘new economy’ in the late 1990s to Canada’s more traditional industries such as energy, mining and transportation.

The increased purchasing power of Canadians was reflected in much stronger growth in recent years of ‘command’ GDP (which adjusts conventional GDP for the terms of trade), nominal GDP and national wealth, which capture the effect of rising prices for what we produce and own. They paint a picture of an economy accelerating, in contrast to the steady growth conveyed by real GDP and jobs. Adjusting for command GDP also reverses all of the gap of real GDP growth between the US and Canada in the last three years.¹

Figure 2

Not all sectors profited equally from these changes in commodity prices and the exchange rate. Many manufacturers were squeezed by the combination of soaring input costs and the rising loonie, notably forestry and clothing. The four-year surge in housing lost some of its lustre. But overall, 62% of industries boosted output last year, little changed from 64% in 2004 and above its long-term average of 59% (the highest value on record is 72% in 1994 as the economy recovered from recession). As a result, the economy was increasingly pushing against its capacity limits, especially in western Canada.

Some trends remained unchanged. Inflation stayed low, despite the energy price shock. This helped keep interest rates near their historic lows. And old habits were hard to break: Canadians continued to buy trucks and SUVs in increasing numbers, and energy consumption grew steadily despite high prices.

Canada remained the only G7 nation where governments overall ran a budget surplus, and one of the few with a trade surplus (along with Japan and Germany). Canada also posted the largest gain in business investment over the last three years, because corporate profits and surpluses were so high. All these developments in Canada owe much to the resource sector, notably energy. Partly as a result, the loonie was the only G7 currency to appreciate against the resurgent US dollar last year (the recovery of the US dollar was one of the most surprising developments of the year, overcoming a record trade deficit of $805 billion).

Steady growth overall…

Canada’s real GDP growth was stable last year at 3%, and the increase in demand in most major sectors was little changed. Consumer spending picked up slightly (despite higher energy prices), government current expenditure growth was unchanged, while export gains eased slightly as prices and the loonie rose. In fact, the only major change in spending patterns was an increase in non-residential construction and a slowdown in housing (partly inter-related, as these sectors are often competing for the same resources).

…masked rapid changes by industry

But beneath this overall appearance of stability, Canada’s economy is undergoing rapid and profound changes, and not just between booming resources and construction and declines in some manufacturing industries. The resource sector is divided between rapid growth in oil and gas and mining and severe cuts in forestry (which will be even more debilitating as the pine beetle infestation spreads). The energy sector itself is undergoing a marked shift from conventional to non-conventional sources such as the oilsands, coal-based methane and liquefied natural gas. Diamonds have emerged as the shining new star in mining. And all sectors have to deal with a shift in trade and travel flows to Asia.

Any period of rapid change triggers fear, and last year was no different. The rising dollar and increased competition from China raised widespread concerns about the erosion of our industrial base, leading some economic forecasters early in 2005 to talk of recession (in retrospect, an unfounded concern). The spread of avian flu to many parts of the world resonated strongly with Canadians, after the SARS outbreak in 2003. Soaring energy prices recalled the economic slowdown triggered by OPEC price hikes in the 1970s. And our growing reliance on resources reawakened anxieties about a recurrence of the notorious boom-bust cycles that have plagued this sector in the past.

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, moderate inflation, 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 two fastest growing markets in the world – the US and China. But central Canada grew enough to lower unemployment, overcoming high energy prices and the losses of manufacturing jobs.

One of the salient features of our economy in the last decade has been the speed with which resources have been shifted between sectors as needed. Growth in the late 1990s was dominated by sectors such as high-tech and auto manufacturing, and ICT services. All these industries have slowed since 2001, with the baton for growth passed to long-neglected areas such as construction, resources, and health and education.

That these changes have been made without a short-term recession (such as in the US in 2001) or long-term stagnation (as in Japan and the larger European nations) attests to the flexibility of markets and institutions in Canada. A striking measure of the adaptability of the workforce is that over half of Canadian workers changed jobs between 1997 and 2003. This adaptability, however, will be severely tested in years to come by the aging of our population, a foretaste of which was a contraction in the labour force last year, the first ever in a non-recessionary year.

Only prices can alter today’s large economies

The origins of these shifts in the economy lie in relative prices, the fundamental mechanism for signaling changes in any market economy. Over the last three years, prices in financial and commodity markets have strongly signaled a need to transfer labour and capital to the resource sector. Starting in 2003, prices in commodity markets have risen sharply, first for energy and more recently for mining products. This increase was reflected in higher stock market prices, with Canadian markets smartly outperforming most other countries (and nearly triple the gain in the US since 2002). Stock market prices recently set a new record, almost double their low in 2003 after the ICT bubble burst. While resources led the gain, 70% of shares rose last year - a reflection of how widespread was last year’s prosperity. The inflow of money into Canada, from both commodity exports and investors, helped boost the exchange rate sharply.

These changes in relative prices provide a useful insight into the workings of a modern macro-economy. Only large price shifts in financial, commodity and exchange markets can fundamentally change the course of a $1.4 trillion economy such as Canada’s, because of their pervasive effect on the decisions taken by millions of households and businesses. For example, the surge in energy and metals prices triggered a shift of jobs and investment to these sectors over the last three years, ending over a decade of decline for our primary sector. The wealth generated in resource stocks helped sustain household spending. These trends were reinforced by the rising exchange rate, which helped lower prices of imported goods for both consumers and firms (saving them nearly $14 billion over the last three years).

The sheer size of the economy gives it the ballast to resist repeated shocks in recent years, ranging from the stock market crash (which wiped out nearly $230 billion of household wealth between 2000 and 2002) to the 9/11 attacks to the recent exchange rate and energy price surge. By comparison, much-discussed events such as the SARS epidemic or the mad-cow crisis (never mind the NHL lockout) are relatively small, not even approaching the $1 billion needed to affect GDP at the first decimal place.

The hurricanes in the US last year were another example of how easily modern economies shrug off disasters that would have been crippling several years ago. The busiest hurricane season ever devastated New Orleans, the 35th largest city in the US, and hampered output all along the Gulf Coast, causing a spike in oil prices to a record $70(US) a barrel. And yet, there was little overall impact on consumer spending or output growth, partly because American GDP is a mammoth US$12.5 trillion (at $1.3 trillion, the US spends more on food than Canada’s entire GDP measured in US dollars). Not only does the immense size of today’s economies act as a cushion against these shocks, but it also provides the deep reservoir of resources needed to tackle problems and challenges as they emerge.

Energy dominated major trends…

The energy sector played the dominant role in the economy last year. 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. The surge in corporate income taxes and royalties from energy buoyed government budget surpluses, especially Alberta’s. Households successfully grappled with higher energy costs, even to the extent of buying more vehicles and driving them farther. Energy was also behind the pre-eminence of the west in regional growth.

Canada’s current account trade surplus rose to a record $30.2 billion, mostly because of a $10 billion increase in the energy balance. Energy exports jumped 28%, to become our leading export at $87 billion. All areas of energy did well, led by natural gas where higher prices boosted exports to $36 billion. Crude oil rose to $30 billion, helped by rising prices as well as several new projects coming online. While still small by comparison, uranium and coal posted the fastest gains, doubling since 2002 to $5.2 billion as European and Asian energy demand diversified outside of oil and gas.

Figure 3

While the short-term pain of higher energy prices has already been mostly absorbed by consumers and business, the benefits in terms of more investment and output will be reaped for years, barring a crash in prices. The net benefit of higher energy prices is shown in Figure 4; while energy did consume a slightly higher share of personal disposable incomes, this was dwarfed by the growth of energy exports in total income.

Figure 4

Energy also drove the 9% increase in business investment last year, its third straight gain and the best in a decade as investment recovered from the ICT crash in 2001 and 2002. Oil and gas expanded 16% (or $5.2 billion), led by a 55% (or $3.4 billion) hike in the development of the oilsands.

…but it too is changing rapidly

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

This has been most evident in oil, where Alberta’s oilsands have grown to 42% of all domestic oil output. At $9.8 billion, investment in the oilsands equals almost 40% of spending on conventional oil and gas. This trend will continue as firms have announced a blizzard of new projects over the coming decade. Canadian firms have led the development of the technology to harness the oilsands, a reversal from foreign-controlled firms domination of energy in the past.

Oilsands output dipped last year, as a major fire disrupted output early on. Production is forecast to rise nearly 30% in 2006, and double to 1.3 million barrels a day by the end of the decade.² Currently, 60% of oilsands output comes from mining, with the rest from in-situ (or steam) production. Mining projects in the oilsands are also more labour intensive than conventional output.

Figure 5

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. Coal-based methane (almost all of which is in Alberta) increased 27% more than the National Energy Board (NEB) forecast in 2004. Investment intentions for coal gas hit $1.3 billion for 2006, equal to over one-tenth of spending on the oilsands although much less publicized.

The need to find new gas reserves is relentless: 50% of natural gas last year came from wells less than 5 years old.³ After rising from 1.4 million m3/d in 2003 to 7 million in 2005, the NEB projects natural gas from coal will triple to 25 million by 2007, to provide one-third of all natural gas and offset declines from conventional sources. The latter is falling due to a 20% per year drop in output from existing wells and the declining initial productivity of new gas wells in the WCSB. The growth of liquefied natural gas promises imports will play a greater role in the future (natural gas imports are negligible now).

All these new energy sources require large investments in the infrastructure to carry and process oil and gas. Natural gas is particularly important to the drilling industry, since the oilsands require no drilling (the lower cost of exploration partly offsets their higher production costs).⁴ Gas also accounts for the bulk of the Alberta government’s royalty revenues as conventional oil supplies shrink.⁵

Canada’s role in natural gas is much different than in oil. Canada accounts for 14% of the world’s proven oil reserves, second after Saudi Arabia, but only 1% of natural gas. As well, the global market for oil is well integrated, while the high cost of transporting natural gas makes its markets more regional, each with its own pricing system.⁶

However, the recent surge in natural gas prices is helping to create a more global market through trade in Liquefied Natural Gas (LNG).⁷ The number of tankers carrying LNG is expanding by a third, while many of the world’s largest gas exporters (notably Russia, Qatar and Norway) are building terminals to liquefy gas for export. Three plants are under construction in Canada to receive LNG imports, and more are in the planning process.

Energy will dominate Canada’s business investment for years to come. Already, the rapid development of the oilsands has created the need for new pipeline capacity to move this product to market. Investment intentions for 2006 show that pipelines are taking the lead in investment growth in energy, with an 83% increase to $2.0 billion. And the rising price differential between more valuable light grades of crude and the growing volume of heavy grades from the oilsands creates the incentive to build numerous refineries.

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. These goods include leading-edge wireless communications equipment as well as more mundane sectors such as machinery (especially for construction and mining, which have nearly doubled to $5.7 billion), metal fabricating, office furniture and non-metallic minerals. Altogether, they contributed nearly half of the overall growth in manufacturing shipments (excluding oil and metals) over the last three years.

Mining and transportation also improved…

The boom in oil and gas spread to other sectors last year, thanks to higher exports. Prices for a wide range of metals, including copper, nickel, iron ore and aluminum, hit record highs, while gold touched its highest level in a quarter century. 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.

The turnaround for mining was all the more striking in light of its desultory performance since 1990, as jobs shrank 53% and investment was so weak that its net capital stock fell in absolute terms. But suddenly, mining jobs rebounded 16% last year, while investment in mining jumped 20%. Non-metallic minerals led the increase, especially potash and diamonds. Investment in metal mining was little changed despite soaring prices, although it remains at high levels after a surge in the development of new ore bodies over the previous two years.

A spin-off of increased demand for commodity exports was a rebound in the fortunes of the transportation sector. Rail and water were particularly strong due to the transport of bulk 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 demand for international travel. All these sectors plan to boost investment substantially in 2006.

…creating a new big 3

Nowhere was the pre-eminence of oil and gas, mining and transportation more evident than in profits. The operating profits of this triumvirate soared by $16.2 billion last year, 80% of all profit growth in Canada, and the most visible sign of the orthodox template of the Canadian economy re-asserting itself. Oil and gas led the way with a $10 billion (50%) increase. Mining jumped $2.7 billion (67%), while transport rose $3.5 billion (45%). In all three, profits were well over double their previous records. Flush with cash, it is not surprising that these three have 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.

Figure 6

By comparison, the next largest profit gain was a $2 billion gain in retailing; manufacturing profits fell $3 billion. Still, manufacturers invested 7% more. All of the increase went to machinery and equipment, where prices continued to fall.

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, saved firms over $10 billion. This saving is rarely noted in discussions about the impact of the exchange rate on industry profits.⁸

With corporate profits garnering a record 14% of GDP, it is not surprising that most measures of corporate financial health are the most robust ever. Firms have used this money to pay off debt and boost cash reserves. Strong stock markets encouraged new equity issues, pushing the ratio of debt to equity to an all-time low.

Is energy 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 that occurred in commodities (notably energy). However, solid arguments can be made that prices will stay ‘stronger for longer’.

First, the current boom is rooted in the integration of several billion people in Asia (especially China and India, home to 40% of the world’s population) into the global economy. Previous jumps in energy prices were driven by cuts to supply (by OPEC in the 1970s and Kuwait in 1990), whereas the current surge reflects continued high demand in the US and burgeoning gains in developing countries (apart from the brief spike in prices last fall due to hurricane damage to the US). Of course, 1998 also demonstrated how a crash in Asian demand could lower oil prices.⁹

This new pattern of demand-driven price increases is reflected in futures prices for energy. While past price increases due to supply shortfalls were discounted in futures markets, the recent lofty level of prices is expected by markets to continue for years. This is important to developers of high-cost projects such as the oilsands, who can lock in these prices and reduce their exposure to risk. The high level of futures prices also reflects the fact that major oil discoveries are occurring only in expensive locations, such as offshore or the oilsands.

It is also important to recall that 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 ICT 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 severe cycles in 1979-1980 and 1981-1982 (the average of output in these two cycles is presented in Figure 5 for the months before and after the peak). The average cycles for housing in 1980-82 and 1989-91 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) in 1980-1982, 1985-1986 and 1996-1998 were smaller on average.

The macro-economy not only survived all these cycles, but has become more stable. There is little reason to think overall growth will be unduly destabilized by the current reliance on resources.

Figure 7

Households absorb energy bills

Meanwhile, Canadian consumers were surprisingly unaffected by the hike in energy costs. Energy bills (mostly gasoline and home heating) 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 the modest hike for electricity rates last year, which cushioned the impact on heating bills from the jump for oil and gas. As well, it also reflects a further pick-up in incomes.

Labour income growth improved to 5.4% as a result of tighter labour markets. Disposable incomes rose slightly less (4%), due to an increase in the tax burden for the second straight year (possibly due to burgeoning stock market profits).

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. Indeed, overall vehicle sales rose for the first time in three years, to 1.63 million units last year, boosted by a surge at mid-year when incentive plans proliferated.

While Americans did reverse their 25 year-long preference for buying more trucks (which include vans and SUVs) 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 (this increase compares with a 0.5 point decline to 55.0% in the US). The resilience of trucks was led by Alberta, where they accounted for a record two-thirds of all sales. Still, demand for trucks remained strong elsewhere (their share actually edged up to 45.7%), notably in BC and Ontario.

Figure 8

The fastest-growing areas of consumer spending shifted from housing and autos to household appliances and electronics. This reflected falling prices and new technologies, notably the spread of wide-screen TVs and wireless communications.

Growth tilted to the west

One of the most striking features of last year’s growth was its concentration in Alberta and BC. These two provinces accounted for 43% of all job gains in Canada, despite representing only 24% of total employment. Growth in Alberta (or Oilberta as some have called it) was driven by mining and construction, while BC was fuelled by construction, real estate and transportation. These increases pushed the unemployment rate to record low levels in both provinces. In fact, growing shortages of labour and materials appear to be the major constraint on their growth.¹⁰

Investment and exports were the driving force in both provinces. The two were related: money earned from a 19% increase in Alberta’s exports and 10% in BC’s was used to boost investment (BC’s export growth was lower than Alberta despite gains in gas and coal, due to weakness in forestry products, still its largest single export). Business investment rose 18% in Alberta and 6% in BC. In turn, the growth of exports and investment boosted employment and household incomes. Not surprisingly, retail sales in these two provinces dominated the national increase, contributing 38% of the overall gain. Housing starts in Alberta and BC also outperformed the national average by a wide margin.

Another measure of the dynamism of Alberta and BC is their dominance in the growth of professional, scientific and technical services. These two provinces accounted for 26,000 of the 31,000 jobs added by this sector last year. This is important, because many of the services provided by this diverse group of lawyers, engineers, architects and computer specialists often reflect the early stages of the business planning process (which is why they are one of our leading indicators of emerging trends in the economy).

While other regions did not benefit as much from the resource and investment boom as Alberta and BC, they did fare well in their own right. In particular, 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 (notably among people aged 15 to 24 and over 55). Ontario managed a respectable 1.3% gain in employment, with increases in construction and services (notably education) outweighing losses totaling 30,000 jobs 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 also benefited from rising investment demand for capital goods and iron and steel, as have more specialized producers in Alberta and Saskatchewan. Indeed, a large majority of Ontario’s manufacturing industries (13 out of 16) outside of clothing, textiles and leather posted higher shipments last year. Outside of petroleum and metals, capital goods have been the fastest-growing sector up nearly 10% since 2002, led by double-digit gains for office furniture, non-metallic minerals, metal fabricating, machinery (especially construction and mining where shipments leaped 52% since 2002) and communications equipment. Iron and steel strengthened by 17%. This reflects how the west’s resource boom is spreading to other regions. Paper and autos have been the main sources of wearness.

The transformation of the industrial landscape was evident in other provinces. In Quebec, petroleum refining has become the second-largest source of manufacturing shipments, more than offsetting declines in textiles and clothing. Increased refinery receipts have also buttressed shipments in Atlantic Canada against losses in pulp and paper. This trend will be encouraged by the construction of LNG terminals. While jobs were little changed in Newfoundland, its exports and incomes fared better, fuelled by the growth of its resource base. In particular, the White Rose offshore oil platform and the Voisey Bay nickel project both started producing late in the year.

Prices and Wages

Consumer price inflation remained low last year despite the 10% surge in energy prices, an unprecedented phenomenon. The increase in the CPI rose from 1.9% in 2004 to 2.2% in 2005, while the implicit price index for personal expenditure (a slightly broader measure) was little changed at a 1.6% increase. The more moderate response of prices in Canada kept interest rates here from rising as much as in the US (where the Fed raised short-term rates two full percentage points, over twice as much as Canada).

The restraint in prices originated in lower prices for durable and semi-durable goods. Both these sectors have a large import content. A rising Canadian dollar, especially against the US dollar (to which the Chinese yuan is essentially fixed), and surging low-cost imports from Asia drove down the price of goods such a clothing, household appliances and electronics.

Since the dollar began to rise in 2003, prices for durable and semi-durable goods have fallen by 2.6% and 1.4% respectively. These lower prices have 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.

Figure 9

The different relationship of demand pressures and prices also has a domestic component. This is most evident in the muted response of wages to the 30-year low in unemployment. Average hourly earnings rose 3.2% last year, up from 2.5% the year before. Almost all of this increase originated in a 7% jump in Alberta, where signs of severe labour shortages multiplied. For example, 20% of manufacturers in Alberta at year end reported that shortages of unskilled labour were hampering production. A pronounced shift of employment in Alberta from part-time to full-time positions and from low-paying sectors (such as farming, accommodation and food and even manufacturing) to high-paying jobs in construction and the oilpatch testifies to the severity of this problem.

Still, nation-wide wage pressures remain muted outside of Alberta. The reasons for this are unclear. Some analysts have speculated that globalization of the labour force was the main reason, instilling in workers in North America the fear of offshoring jobs to the cheap workforces in Asia. But offshoring outside of manufacturing remains negligible, and does not explain why wages have not accelerated in sectors where trade is not a factor, such as resources, construction and many services. Another reason might be the large potential pool of unused labour in Canada.

Youths and women left the labour force

Labour force participation shrank last year, the first time it has contracted outside of a recession. Even more curiously, the drop occurred with unemployment at a 30-year low and wages accelerating. The decline was led by youths aged 15 to 24 years and adult women, mirroring similar drops in the US (although it began earlier in the US).

Youths withdrew from the labour force in most provinces, especially young men. Conversely, the lower participation rate for adults 25 to 44 was mostly due to women. This is a notable break from sustained increases for adult women for several decades (the only previous declines on record were in the early 1990s recession), which lifted their participation rate from 54.0% in 1976 to 82.2% in 2004, before retreating to 81.8% last year.

The reasons for the decline among adult women are unclear. It was concentrated in BC and Alberta, falling almost two full points in both provinces (hitting a 13-year low of 79.3% in Alberta), despite their tight labour market conditions. Some of the decrease can be attributed to more 25 to 29 year-olds staying in school, a phenomenon evident in other provinces. But the largest declines were in older age cohorts, especially for women aged 35 to 44 years in Alberta, whose participation rates have been falling since the late 1990s. One explanation could be that incomes are so high that households no longer need two paycheques. Another is that child care 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.

Figure 10

The tightening of the labour market may be a precursor of developments over the next couple of decades as the boomer generation moves into age cohorts typically associated with retirement. But indications here too are that the past may not be prologue to the future. To date, the movement of boomers into the 50 to 60 age group has accompanied a sharp increase in employment and labour force participation of these age groups. A major question is whether this will continue as boomers age, especially after 65 when participation rates have always fallen sharply.

More investment starts to lift productivity

Another feature of the last three years has been weak labour productivity growth. After two years of no change, labour productivity did begin to pick up during 2005, presumably as firms began to reap the benefit of recent investments. Manufacturers led the increase in productivity as they were under the most pressure from the rising dollar. This gain was partly offset by a 10% drop in mining, reflecting how the energy industry is shifting output to more marginal and difficult sources (oilsands mining, for example, uses more labour than conventional and offshore projects).

The rising cost of labour relative to capital will give firms an added incentive to continue to invest more. Wages (measured by average hourly earnings in the labour force survey) accelerated last year as a result of strong demand for labour in Alberta and BC, while the supply of labour was constrained by a lower labour force participation rate. Conversely, the cost of capital has fallen 3% over the last three years (using the implicit price index for business investment), due to lower prices for imported machinery and equipment. As a result, the ratio of the cost of capital to labour has fallen almost 15% so far this decade.

Figure 11

International developments

Several other notable developments were seen in our dealings with other countries last year. Canada continued to pay down its foreign debt, while increased buying of foreign bonds raised interest receipts. This not only gives a boost to the current account balance, but also lifts nominal GNP relative to GDP: the former grew by 6.4% versus 6.1% for the latter, widening a gap that began in 2002 and now totals 1.3 percentage points. This is because Canadians are keeping more of the income they generated for themselves rather than servicing debt held by non-residents: interest payments to non-residents have fallen nearly 25% so far this decade.

Foreign direct investment in Canada rose by $40 billion after two years of Canada repatriating foreign-owned companies. Investor interest was driven by energy and mining. Canadian direct investment abroad slowed by almost half from a near-record $62 billion pace in 2004. Canadians bought $42 billion of foreign securities, partly in response to the lifting of the ceiling on foreign content for RRSP holdings.

Canada’s travel deficit hit a 12-year high of $5.5 billion last year, fuelled by record spending abroad. One measure of the rising wealth of Canadians is that they took 14.9 million overnight trips to the US, more than the 14.4 million trips Americans took to Canada despite their having 10 times our population.

Canada’s steady 3% real GDP growth last year compares favourably with a slight slowdown in worldwide growth from its peak in 2004. High energy prices and rising interest rates helped rein in the US expansion to a still robust 3.6%, while China and India continued to barrel ahead at near double-digit rates. The industrialization of China was particularly important in fuelling the commodity price boom. The sustained rapid growth of the global economy is all the more impressive in view of the tsunami that devastated coastal regions in Asia at the turn of the year.

While Japan showed signs of snapping out of a prolonged, deflationary slump, the major European countries continued to struggle. Real GDP growth remained anemic at 1% or less in France, Germany and Italy. The accompanying chronic double-digit unemployment rates fuelled increased social tensions, notably riots in France. Germany’s export sector showed one of the few signs of dynamism, profiting from growth overseas in China and the Middle East. Ireland and countries in Eastern Europe (many new members in the EU) remained the fastest-growing parts of Europe, encouraged by innovative policies on investment and taxation.

Conclusion

Canada has reverted to its more traditional orientation over the last three years, as prophecies of a new, tech-driven economy have not been realized. Surging demand for energy and mining products was the dominant theme of the year. This reflected sustained growth in the US and the increasing integration of the BRIC (Brazil, Russia, India and China) bloc of countries into the world economy. The emergence of the BRIC bloc also gives Canada alternative markets to the US.

The spin-offs from the energy and mining boom affected many industries. Transportation benefited directly from the need to carry these commodities to their export markets, especially on the west coast. Construction profited from both new investment projects as well as housing demand brought about by the wealth in western Canada, which also boosted retail sales. Government coffers in energy-producing provinces were swollen by royalty revenues.

Canadians in all regions also benefited from these changes, led by energy in the west. The stock market surge lined the pockets all shareholders, most of whom are in central Canada. The rising loonie lowered the cost of imported retail goods, and also limited the upward pressure on interest rates. The investment boom also drove the expansion of the large capital goods industries in central Canada.

Canada’s recent prosperity was not based only on a resurgence of its long-moribound resource sector. It also reflects a successful marriage of its traditional industries with a recovery for some ICT products, notably wireless communications and Internet service providers.

So far, Canada has adapted well to these changes. Energy was increasingly produced in new and unconventional ways. A number of factors point to sustained gains in the resource sector, while construction work for the 2010 Olympics has only started. Still, the unexpected can always happen, just as the current changes in the economy were unimaginable just a few years ago when resources were at their nadir and high-tech at its peak.

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Notes