‘The most concerning piece is the trade war between China and the U.S.’

| September 29, 2019 | 0 Comments

Pedro Antunes is the Conference Board of Canada’s chief economist. He joined the organization as an economist in 1991, after working with the Canadian forecasting group at the Bank of Canada. He has moved progressively into more senior positions. Prior to his current role, he was responsible for custom research work and economic analysis at the Conference Board.
In addition to publishing regular forecasts, he researches the impact of demographic change on the fiscal sustainability of health care, productivity and long-term economic growth. He has contributed to several international projects, helping decision-makers in Tunisia, Morocco, Jordan and Ukraine develop appropriate forecasting and policy-analysis tools. He sat down with Diplomat’s editor, Jennifer Campbell.

Diplomat magazine: What’s going right in the global economy?
Pedro Antunes: (Laughs.) What’s wrong with it might be more of a question. Well, I guess when you look globally, I would go back to 2018. In 2018, we were finally starting to see the stars align in some way and I think some of that’s still true, in the sense that there were no major regions in the globe in recession. If we go back to early 2010 and 2011, we had Japan, we had the euro crisis. Then in 2015, resource prices collapsed, so Russia and Brazil were in real trouble in the sense that growth was actually negative. And in our own backyard, we had Alberta and Saskatchewan suffer the same kind of impacts.
When we got to 2018, it’s not as though anyone was doing tremendously well, but we didn’t see major recessions around the world so it did seem as though global growth was getting a little bit better. Despite all of the protectionism, we did see trade volumes increase significantly in 2017 and 2018, so that was good news. But now, unfortunately, a lot of that has kind of gone away. I would say we’re still in a situation where we’re not seeing major recessions although there are some problem areas for sure. The global economy is still expanding, although at a lesser pace than we saw in 2018. Global trade is [also] still expanding, although at a lesser pace.
Going forward, most of the concerns are around risks. Where are some of these major geopolitical impasses? First and foremost, it’s trade issues with respect to the U.S. and China, with Canada and China. Where are the politics taking us? Those are issues. Aside from tariffs and all these other risks is the lack of independence for the Fed in the U.S. We’ve only seen a few modern economies in the world where there’s been a push against the autonomy of the central banks. This is concerning. The U.S. is one and Turkey is the other.

DM: Trump’s bullying the Fed is a big one, isn’t it?
PA: I’m not sure why financial markets aren’t scared silly over that. But so far so good. To have a U.S. president push his views on the central bank is something that really moves away from what economists have been talking about for years. It’s a bit concerning.

DM: On trade, do you think Canada is falling behind?
PA: It’s a real problem for Canada. It’s such a big story, I don’t know where to start. There are two issues. One is a capacity issue. When we think about our major export categories going into the U.S. with higher value-added exports like machinery, equipment, transportation, autos and parts, etcetera — where the problem has been, stems from the lack of investment in Canada.
When we think of our economy on the supply side, we think of it like a firm. We think about the amount of labour we have, we think about productive capital that we have and that, along with productivity, allows us to generate output or GDP. The problem for Canada has been that yes, we saw the resource sector take a big hit in 2015, but at the same time, the narrative was that we’d see a huge amount of investment in our traditional sectors, like manufacturing. We’ve been waiting for that for four or five years. In recent quarters, that automation and retooling investment has been bouncing around a bit, but the levels are still very weak and the amount of capital accumulation is almost nil. When you think about machinery, equipment, automation, the amount of investment is barely keeping up with depreciation. For a developed economy, where we’re seeing the capital-labour ratios — the amount of capital per worker — declining, this is not good news and it shows up in our productivity.
That’s part of the story, but for the trade piece, when I think about our trade with the U.S., it’s about capacity. We haven’t had the investment and we can go on at length about why [that is.] Let’s start with [too high] corporate tax rates, [needing a] more friendly business environment, especially if you’re a polluter. Let’s go to the uncertainty around trade — will we have access to the U.S. consumer? All of these things are creating a lot of uncertainty and investors are choosing to go elsewhere with respect to those traditional investments.
That’s the supply side issue. The other issue is our big markets — the U.S. and China. The U.S. is our biggest market; 75 per cent of our exports go to the U.S. and only 4 per cent go to China. But guess what? China has allowed us to grow our trade very nicely over the last number of years. In 2018, we grew exports into China by 17 per cent or $4 billion worth of extra revenue. It’s all in agri-foods. This year, with the Huawei issue, we’ve been hit on all of those. You can take a look at the trade data and see the biggest categories where we trade with China — canola, soy, peas, red meat products — those have all been hit and we’re just not sure what’s going to happen. It’s a huge concern. We’re not going to perform well in 2019 with respect to trade with China. What’s the future hold? Can we diversify our exports elsewhere? We have seen canola move into other markets, but at a reduced price.

DM: In thinking about the G7 that took place in August, how can global leaders minimize the trade chaos that U.S. President Donald Trump’s causing?

‘If everyone believes there’s going to be a recession, there will be.‘

‘If everyone believes there’s going to be a recession, there will be.‘

PA: In some respects, the U.S. has a quarrel with China because China ascended to the WTO under the premise that it would open its market and move away from state-owned enterprises. So I do think the U.S. has a legitimate issue to contend with. I do want to make that point. The rest of the world, and the U.S. as well, depends very much on China. They’re gaining importance, but they’re really not opening their markets. Whether the Chinese really have a free-floating exchange rate — I’m very doubtful of that. I suspect it’s very much managed in their system.
So I think the U.S. has a legitimate case, but is [the U.S.] going at it the right way? It’s tough politics, for sure. Although the U.S. has a legitimate beef, it has also applied tariffs with every G7 country — even its dearest allies and friends, like Mexico and Canada. It’s not been fruitful in the sense of keeping its allies close.
I think there’s a misunderstanding by the U.S. administration around what the benefits of trade are. The administration has portrayed the difficulties in restructuring and manufacturing with some of their traditional industries as a trade issue, but it’s had more to do with automation. Canada’s lost just as much in terms of its manufacturing workforce.
Automation is taking over the world. I think there’s a misunderstanding or a misrepresentation over what that restructuring was about. To put up tariffs on steel and aluminum and pretend that this will bring back some of these industries is false. How you deal with it from a G7 perspective, it’s a tough situation. I think you continue to try to message your beliefs, what the truth is. Try and tell the truth as much as possible and hopefully somebody will listen.
We also need to acknowledge that when you open up borders, that does increase competition and some industries will lose. I think we perhaps have failed to acknowledge that to the extent that we should. Perhaps the U.S. wouldn’t be in this situation if there’d been more acknowledgement of that.

DM: What countries should Canada be pursuing for free trade agreements?
PA: I think we’ve done really quite well in terms of bilateral trade. The government has been focused on it. What else could you do when your biggest partner isn’t so open to trade anymore? We did a lot as the dollar appreciated very strongly in early 2000 and then in 2011 and 2014. There were some natural pressures to diversify our trade. In the meantime, Canada’s been working very hard on trade deals all over the world. There are many that are still in progress. The CPTPP [The Comprehensive and Progressive Agreement for Trans-Pacific Partnership] is coming to fruition, the European trade agreement was a great opportunity. We’re a small market in comparison to the EU, there is a lot of opportunity there. Canada was pretty slow to get into China, though we’ve done better in the last 10 years.
When we think about where global growth is going to happen, think about Asia. If you include India (1.37 billion population) and China (1.43 billion) and the ASEAN economies (622 million), I think we’re talking about more than 44 per cent of the world’s population. We’re talking about economies that are growing at 6 per cent. India has done quite well to try and unify that market and make it an easier place to trade. We’re thinking about a deal with India. With the ASEAN economies, Canada is looking there, too. Some of those economies are growing — Thailand, Philippines, Vietnam.

DM: What’s Canada’s best approach to trade with China?

‘We’re not going to perform well in 2019 with respect to trade with China.’

‘We’re not going to perform well in 2019 with respect to trade with China.’

PA: It’s a political issue. It eludes me what’s going on there behind closed doors. We’ve been stuck in a very difficult situation. [Some have said] we could have been conveniently incompetent on the extradition piece, but I think we’re stuck in this at this point. We’re a net importer from China, but can we really hurt the Chinese export market? We’re really not in a position where we can bargain very strongly against an economy that will not necessarily feel big consequences. We’ve leveraged what we can, we’ve made our grievances quite well known. I think the best practical approach is to try and facilitate our exports to other areas. We’ve had some success with canola just recently. The prices are down about 10 per cent, which isn’t bad. With some of these crops, the swings can be great. A 10 per cent hit [isn’t bad] — at least they’re able to clear inventories.

DM: Looking at the economy globally, what are some trouble spots and how does one remedy those?
PA: The most concerning piece is the trade war between China and the U.S. that keeps escalating. I think we may continue to see that. What’s surprising is how a tariff war translates into a recession. It does so by affecting prices for consumers. The first thing we should be seeing is U.S. consumer prices ratcheting up. And let’s not forget that the U.S. consumer is 75 per cent of the U.S. economy or 14 to 15 per cent of global demand. That’s how the recession would happen. The problem I’m having with this is that yes, we keep seeing tariffs come in, but we’re not seeing it on the bottom-line inflation numbers for the U.S. I would say it’s concerning. The U.S. continues to threaten with these tariffs, but right now, the biggest concern I have is not so much with the tariffs having an impact on prices, it’s more the tariffs having a psychological effect on markets. If everyone believes there’s going to be a recession, there will be.
If we start to see inflation come up in the U.S., that will be a clear sign that we’re starting to have an impact and this is where the Fed will be stuck because what is your solution to a softening economy? It’s lower rates, but you don’t lower rates when you’re trying to control inflation. What you want to do is just the opposite.
Typically, when an economy slows down, there’s excess supply, prices come down and that’s when you get your recession. But so far. so good. The wholesale retail industries are very competitive in the U.S. There are things around automation that are helping to keep prices down. [Still,] a 25-per-cent tariff is a big tariff, so why isn’t it showing up in inflation?
Similarly for the Chinese market — it’s one that’s becoming much more consumption-dependent. We can sell higher-value goods into that market because they’re a consumer economy. The Chinese are targeting tariffs on agri-food, which should bolster prices in that market, which is the second-largest consumer market in the world. Certainly for many goods it is. They’re consuming more autos in China than they are in the U.S., also more lobster, Cuban cigars — you name it.
At the Conference Board, we keep talking about lagging productivity. I’ve lived through this before. [Information technology] was going to change the world. Maybe it did, but we didn’t see it in the numbers. Now it’s blockchain, AI [artificial intelligence,] automation that’s going to change the world, but we don’t see it in surveys from Statistics Canada. I hear people saying AI is going to disrupt the workplace and we’ll see all these workers leave, but [it’s not happening.]
These disruptions would be positive because they generate productivity gains, which is more income for the same inputs. We’re just going to see more income per hour worked. So yes, if these disruptions happen very quickly, that would be a concern, but at the same time, I doubt it’ll happen that fast. We need solutions to our labour market challenges to up our productivity and up our ability to grow our economy.

DM: Can you talk a little bit about more the cure for low productivity?

‘We also need to acknowledge that when you open up borders, some industries will lose.’

‘We also need to acknowledge that when you open up borders, some industries will lose.’

PA: For us, the definition of productivity is the amount of income per hour worked. If I’m digging holes with a shovel or backhoe, there’s a huge difference in my ability to produce. That’s a clear piece and to me, that’s of most concern. We saw our employment grow. It’ll grow by more than two per cent this year and our capital-to-labour ratio is going to erode in 2019. We know that has a negative impact on productivity. Unless we’re not measuring correctly, it doesn’t look good.
The other thing that affects productivity is the efficiency with which capital and labour mix to produce output — the magic. We call that total factor productivity. The point being that there are things that happen within the production process that are harder to measure. You can think about companies that come up with more efficient processes, workers who are more highly trained. We can capture that in some respects. We try and gather benchmarks that may help us. Is it investment in R&D? Is it new technology? Products?
On the second measure, we do an innovation score card for Canada and we don’t really rank [all] that well. It’s not a Canadian problem. You look at productivity in all of the developed economies and it’s not good.

DM: What do you do about it?
PA: I would start with the capital-to-labour ratio piece. It’s the investment piece. We need to make sure Canada is a more business investment-friendly environment. How do you do that? We talked a little bit about tax rates. We aren’t competitive with the U.S. on tax rates. When you look at the effective rates — the amount of tax paid by corporations to the state and federal level as a share of profits — the U.S. is very heavily subsidized for investment. [Corporate taxes] are actually really low in the States, especially after January 2018 when they came down significantly. Do we want to be competitive on tax rates and have a deficit that’s five per cent of GDP? It’s a tough situation. Signing CUSMA [the Canada-U.S.-Mexico Agreement] and seeing if we can get that ratified, that would be helpful even though CUSMA’s not perfect.

DM: Are you worried about a global recession or regional ones?
PA: Because we haven’t seen inflationary pressures, the effects of tariff wars haven’t shown up yet. The biggest concern is that there’s enough uncertainty and volatility in equity markets right now, so there’s an expectation that, sooner or later, we’ll hit a business cycle. But what concerns me is that self-fulfilling prophecy. What’s happening with bond yields [is worth noting]. We’re seeing enough concern that people are willing to take very low returns on safe money. In Europe, people are willing to take 10-year bonds at a negative interest rate because they feel that that’s where they can more safely hold their money.
There’s enough belief out there that interest rates are coming down and you might see a slowdown, that it starts to be a concern. Things have been a little better in equities, but they’re bouncing around. Since 2008, when we saw the effects of panic, we’re all more attuned to the effect that business and consumer confidence can have on the economy.
Up until then, I would have said it’s really hard to see the U.S. economy going into recession without some major shock — a financial crisis or an oil price shock or something. Right now, the U.S. economy is firing on all cylinders. The labour markets are really tight, we haven’t seen this erosion in purchasing power in part because inflation continues to be low and real wages are starting to pick up.
For regional recessions, some parts of Canada have been [in recession]. The outlook for Alberta and Saskatchewan [is that they] are seeing modest declines in GDP for this year. Both of those economies are still dropping off. Commodity prices are weak and the investment environment is very weak, so we’re seeing those economies still suffering.

Atunes said dealing with Trump as a G7 member requires leaders to “tell the truth as much as possible and hopefully somebody will listen.”

Atunes said dealing with Trump as a G7 member requires leaders to “tell the truth as much as possible and hopefully somebody will listen.”

DM: With low interest rates, are Canadians carrying too much debt?
PA: For Canada, the biggest concern is some sort of collapse in home prices. People are concerned about home prices being overvalued and that leaves a lot of households in a difficult financial situation because they’re heavily indebted, there’s no doubt. But I don’t see [the collapse happening] because I think households in Canada have been fairly rational. They’ve chosen to buy the most expensive real estate they can afford with their credit. It’s been a very rational choice because home values are appreciating. It’s either that or you put your money in the bank and you lose on it.
The other thing I would say is that when you look at interest costs and take both mortgage and other credit [into account], we’re at record low levels despite the fact that we have a lot of debt. If you add on principal, we’re starting to inch up a little higher. Some households would be stretched if interest rates came up, but that doesn’t look like it’s going to happen. The only other thing that could happen would be a collapse in home prices. We’ve thrown the gamut [at controlling home prices] to try to slow price appreciation and we’ve had some success. The last thing we want is a government policy that would actually see a drop in prices by 10 or 20 per cent. Instead you want to slow home price appreciation.
I just don’t see [debt] as an issue. Demand is real, solid. There is some influence of foreign buying, for sure. We’ve seen some of the impacts of that. We’ve seen the prices come off on higher end homes. And then we’ve seen some effects of government policies, such as tightening up of mortgage rules and then loosening them. I would say governments have had some success.

DM: When the tightening comes, how dangerous is it to increase rates and cause foreclosures and bankruptcies?
PA: I would agree that there is some risk if we had to increase rates, but at this point, I just don’t see it happening. I think governments are tending to go the other way. In Canada, we’re not really in a tariff war with anybody, so there’s no reason for prices to come up here unless they start coming up in the U.S. and then there are impacts of imported inflation, but really, we haven’t seen that.

DM: In 2017 and 2018, was government spending too high and if so, what were/are the tax-increase implications of that?
PA: It goes to the question of sustainability for the federal government. Of course, the government is in a pretty good position. We’ve seen government revenues come in better than expected since the [Liberals] came in. That’s been very positive. We could have done a little bit better in terms of at least targeting a balanced budget somewhere down the line. The reason isn’t that it’s not sustainability, it’s that if your fiscal anchor is debt to GDP, that’s fine, that can only go the wrong way in the case of a recession. Our sense was that federally, it’s sustainable. Yes, there’s still a gap in infrastructure and there are a lot of things that need fixing. It would also be nice to see the government being able to do that with some plan down the road to a balanced budget.
The other piece is that the provinces aren’t in such great shape. Often the federal government hasn’t had to be the backstop to any of the provinces. When the ratings agencies are looking at Canada, that’s in the back of their minds. Our fiscal situation is looked at holistically. When we look at the provinces, a number of them are in difficult shape. [Newfoundland and Labrador, Ontario, Alberta and Saskatchewan are the in the worst shape.] Those challenges are because of health care expenditures and demand for health care though it’s seemingly not the big item on the agenda for the next election.
DM: Is the spending a stimulus or just a pre-election vote ploy?
PA: I think governments are always influenced by the calendar of events that is a four-year period for elections. However, I do think that time and again, we have seen the books come in better than expected. We could have put some of that aside and not necessarily spent it all. We pretty much spent every cent available to keep that deficit at its target. It’s not great — the deficit is just below 1 per cent of GDP — $20 billion. But the U.S. is at 5 per cent of GDP.

DM: How is Canada doing in terms of GDP growth?
PA: This goes back to that story about investment. If I can go back to that narrative where we saw oil prices collapse and we said the energy sector isn’t going to drive growth. In 2011 to 2013, Alberta was a huge driver in income creation in Canada. The narrative was that we’re going to see more balanced growth across the country. Ontario and Quebec and other provinces will do better and we did see that for a while. The dollar deteriorated, but the trade sector did come back. But the problem has been that that evaporated very quickly because we weren’t investing. We were very quickly at full capacity on trade. What comes next? Investment. But it didn’t come and it didn’t come. That was [partly] caused by uncertainty around CUSMA. All of that causes some grief, but even as that got resolved, we haven’t seen investment pick up.
In essence, it’s been very disappointing on the investment side. We’ve actually done not too badly because we’ve covered up that lack of investment and productivity with government spending and household spending. Consumers have been driving everything that happens. We talk about a trade and export open economy, but that’s not what’s been driving growth; it’s been the consumer. How long can that keep going? We keep saying the consumer’s going to deleverage next year and we’ll see investment do better, but we’re not seeing that panning out. That’s the biggest concern or challenge. Is Canada’s economy doing well? Well, we’re not doing well because the supply side doesn’t have the investment, the labour supply isn’t growing by much. Supply-side economy is capital, labour, we’ve upped immigration, but there’s limited availability of labour. The capital-to-labour ratio is deteriorating, and productivity growth is nil.
We’re essentially a weak economy. We’re looking at 1.4 [per cent growth] for 2019; perhaps 1.9 for 2020. I’m worried about [getting to] that number for 2020 for all of the reasons we’ve talked about, but mostly about the trade issues. And if we get to 2 per cent, that’s essentially our capacity. Not that long ago, we had an economy that could grow at 2.7 per cent because we had so much investment. Given the productivity numbers, the labour force growth and the investment we currently have, our potential for growth is well below 2 per cent right now.

DM: Housing costs are high because of low interest rates, which is causing a housing shortage. How do governments solve that?
PA: Housing is a market issue. I’m just finishing a paper on immigration that talks about how to get people to go outside the greater Toronto area. One way to do that is that housing costs are cheaper. I think that’s one natural way to help balance some of these things that are happening. In our report, we also talk about some policy recommendations that governments may look at to help move these things as well. The idea that governments should go into cities with big major investments in affordable housing — I’m just not sure that’s the right policy. There is affordable housing, it’s just not in the GTA.

DM: How much do provincial barriers to trade harm business in Canada? Estimates say removing them could substantially increase GDP.
PA: This has been such a thorn for so many years. Unfortunately, we’ve had more success at aligning the provinces when we’ve signed free trade agreements with other countries.
Here in Canada, there are all kinds of things, especially when it comes to some of our supply-managed products and our alcohol and tobacco. It does affect our ability to sell within our market first and we do know that success at home can help breed success abroad. If you have a certain critical mass, it’s easier to export. The cost of having all these regulations is hard to get at because they’re across so many different areas. We did look at the benefits of standards. We do know that when you align things in certain industries, it does help growth. But with respect to just saying we have so many non-tariff barriers, if we were to eliminate them, what would it save? It would obviously have a positive effect. There’s no doubt.

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