Over the past half-decade or more, the title of North America’s strongest economy has consistently gone to one country: Canada.
While the U.S. is still suffering from the effects of a massive real estate bubble and subsequent financial crisis, the Canadian economy suffered just a short recession (three quarters of negative growth versus four quarters in the U.S.) and has grown at a faster rate than the U.S. for three out of the past four years. Canada was also the first nation in the G7 association of the world’s most advanced economies to regain the GDP it lost during the recession.
The relative strength of the Canadian economy during and following the financial crisis has been mostly attributed to the differences in structure between the Canadian and U.S. financial systems. Canada has a highly concentrated and highly regulated banking sector, which gave both regulators and bankers a better ability to rein in dangerous excess. And the fact that Canada’s banks were spared from the worst of the financial crisis meant that they could keep credit flowing following the recession, giving the country a huge advantage over developed peers.
The Canadian economy has relied on the export of raw materials like oil. Like another fast-growing developed economy, Australia, Canadian economic growth has benefitted from the insatiable demand for raw materials from emerging economies, like China, which need fuel for their manufacturing-led economic surges.
But these advantages may be fading as the Canadian economy is now showing some of the flaws that have plagued its advanced peers in recent years, like high unemployment, a struggling manufacturing sector, and an over-indebted consumer population. Last week, the Canadian government announced that its economy lost 9,400 jobs in June, and that its unemployment rate ticked up to 7.1%. This contrasts unfavorably to what’s going on in the States, where job growth has been stronger over the past year than at any point in the recovery, and where the unemployment rate sits at 6.1%.
Government statisticians in Canada measure unemployment differently than how it’s measured in the U.S., and when they apply the American methodology, they find that U.S. and Canadian unemployment are both at 6.1%. But the fact that the U.S. has finally caught up to its northern neighbor by this measure is impressive when you realize that unemployment peaked at 10% in the U.S., versus 8.7% in Canada during the crisis.
The exchange rate offers yet another indication of American economic strength. For much of the recovery, the Canadian dollar has been more valuable than the U.S. varietal, but that too has reversed recently, with the dollar-to-loonie exchange rate rising above 1 this year:
So, what explains this shift in relative economic power? For one, Canada’s energy export sector can only take the economy so far. As Aron Gampel, a Scotiabank economist wrote in a recent note to clients:
“Alberta is the epicentre of economic activity, benefitting from continuing energy-related investments and expanded production, solid immigration and job gains, and strong retail and housing activity. Most other provinces are languishing in much slower gears, a reflection of the persistently slow pace of growth in the U.S. and around the world … and the slowdown in the pace of job creation.”
Meanwhile, whatever growth the Canadian economy is getting from the consumer is coming more from growing debt loads rather than higher wages. The average Canadian owes $1.63 for every $1 dollar she earns, compared with around a 1-to-1 debt to income ratio in the U.S. Take a look at the chart below from Martin Barnes of BCA research, which shows the trajectory of the debt-to-income ratios for the two countries since the financial crisis.
While the financial crisis interrupted the growth of consumer debt in the U.S., Canadians have continued to borrow, a trend that could not help but goose growth over the past two years. Despite the advantage of great wealth in the form of natural resources, Canada is still vulnerable to the headwinds facing most developed countries. Outside the energy sector, Canada is struggling to increase wages in the face of foreign competition and is, like the U.S., relying on growing debt loads to increase living standards.