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Canada's State of Trade: Trade and Investment Update – 2009

Executive Summary

Buffeted by a deepening crisis in financial markets, global economic activity slowed to 3.2 percent in 2008, from 5.2 percent in 2007. However, the financial crisis entered a tumultuous new phase in September of last year that has badly shaken markets and provoked an unprecedented contraction of economic activity and trade. The advanced economies experienced a 7.5 percent decline in real GDP during the fourth quarter of 2008, and output is estimated to have continued to fall almost as fast during the first quarter of 2009. Emerging economies too are suffering badly and in the fourth quarter contracted 4.0 percent in the aggregate. While the rate of contraction should moderate from the second quarter onward, the IMF projects that world output will decline by 1.3 percent in 2009 as a whole and recover only gradually in 2010, growing by 1.9 percent.

The U.S. economy slowed for the fourth straight year in 2008, as real GDP in that economy managed to expand by 1.1 percent, compared to increases of 2.0 percent and 2.8 percent in the two preceding years. Performance was anaemic over much of the first half of 2008, before turning negative in the second half of the year. Real GDP fell 0.5 percent in the third quarter before plunging 6.3 percent in the fourth quarter, as the full force of the recession took hold. Growth in the euro area slowed to 0.9 percent last year, down two thirds from the 2.7 percent rate registered in 2007. As in the United States, economic activity in the region suffered a sharp contraction in the fourth quarter of 2008, declining by 6.0 percent. Growth in Japan fell 0.6 percent for the year while the U.K. economy managed to expand by 0.7 percent in 2008, as both economies posted declines in real output over the last three quarters of 2008.

The emerging economies were initially thought to be relatively shielded from the crisis as they had improved macroeconomic fundamentals and limited exposure to U.S. securitized assets. However, the crisis has spread to the emerging economies via the trade channel and has dramatically affected these economies. Growth fell from 13.0 percent in 2007 to 9.0 percent in 2008 in China, from 8.1 percent to 5.6 percent in Russia, from 9.3 percent to 7.3 percent in India, and from 5.7 percent to 5.1 percent in Brazil.

In line with the deteriorating global economic situation, the pace of real activity in Canada fell sharply, as growth in real GDP fell from 2.7 percent in 2007 to 0.5 percent in 2008. The economy contracted in the first quarter, rebounded over the next two quarters, then declined sharply in the final quarter of the year. Half of the provinces—Prince Edward Island, Nova Scotia, Quebec, Manitoba, and Saskatchewan—and two territories—Nunavut and the Yukon—posted growth for the year, while the remaining five provinces and one territory experienced a contraction in economic activity in 2008. Net new job creation, at 259,400, slipped to its lowest level since 2005, as the Canadian labour market was buffeted by the economic downturn experienced in the second half of 2008. Employment had been on an upward trend and reached a peak in October. However, the economy shed 83,700 jobs over the final two months of the year, and the unemployment rate climbed to 6.6 percent to close out 2008. Consumer prices rose by 2.3 percent over the year as the rate of inflation edged up from the 2.2 percent rate posted in 2007.

World trade was characterized by highly volatile prices for primary commodities in 2008. The value of world merchandise trade grew by 15 percent in U.S. dollar terms and world services trade increased by 11 percent. On this basis, Canadian merchandise exports grew at roughly half the pace of world trade—by 8 percent—while Canadian services exports grew by one fifth the world average, or by 2 percent. However, in volume terms world merchandise trade expanded by only 2.0 percent in 2008, down from 6.0 percent in 2007, and well below the 5.7 percent annual average rate registered over 1998-2008. Moreover, much of the decline was concentrated in the second half of the year—the months since September have seen precipitous drops in global trade.

In Canadian dollar terms, the value of Canada's exports of goods and services advanced by 5.2 percent in 2008, with goods exports expanding by 5.8 percent and services exports up by 1.1 percent. On the import side, imports of goods and services grew by 6.3 percent, with goods imports ahead by 6.3 percent and services imports up by 4.7 percent. Over the first half of the year, trade values were greatly influenced by rising commodity prices. However, demand weakened as the global recession became entrenched, commodity prices fell, and trade began to weaken towards the end of the year.

For the year as a whole, exports and imports of goods and services to and from all major markets increased, with the exception of imports of goods and services from Japan, which declined. For merchandise exports, Japan regained third position in the ranking of Canadian export destinations, and China moved back to fourth position, while South Korea moved up three places to become Canada's seventh-largest export destination.

Gains in export values were price driven, as volumes fell 7.7 percent in 2008. The effects of the strong price increases that dominated commodity markets over much of the year were particularly reflected in the trade performance of the resource-based sectors. With the exception of the forestry sector, where the downturn in U.S. housing activity clearly impacted Canadian exports, increases in the value of exports were restricted to energy products, industrial goods and materials, and agricultural and fishing goods, as exports of machinery and equipment and consumer products declined. The slowdown in the U.S. economy created severe difficulties in the automotive sector as Canadian manufacturers and auto parts industries experienced plant closures and cutbacks in production, output, and exports last year.

On the import side, most sectors recorded increases in 2008. The growth was attributable to a combination of higher prices and volumes. The increase in prices was the result of rising commodity prices over the first part of the year and the depreciating value of the Canadian dollar vis-à-vis the U.S. dollar in the second half of the year. Only forestry products and automotive products experienced lower imports in 2008.

In terms of specific products driving Canadian trade performance in 2008, crude oil, non-crude oil, and other petroleum gases (primarily natural gas) dominated Canada's trade in energy products in 2008, accounting for much of the growth in both trade levels and in the trade surplus. Trade with the United States was the driver behind the growth for much of the 2008 energy trade; however, for coal, it was strong demand from Asia due to regional supply difficulties. In the automotive and automotive-related sectors, again it was trade with the United States driving the changes; however, in this case, trade was contracting and there was a sharp deterioration in the trade balances for passenger cars and motor trucks.

Outside of energy products, other resource products that had considerable influence on Canadian trade in 2008 included wheat and canola, where strong price increases and good harvests in Canada along with poor harvests elsewhere helped boost export levels, but strong prices also raised import values. Gold enjoyed a banner year, as prices reached record highs and demand was strong, boosting both exports and imports, and sulfur also boosted mineral and metal exports. Exports of potash rose significantly, driven by the U.S. and by major emerging economies, while uranium exports fell sharply to Europe.

In advanced manufacturing, telephone equipment and parts experienced a sharp decline in exports and strong growth in imports in 2008. Both exports and imports of aircraft fell in 2008 with declining demand in both the United States and Canada. However, gas turbines, largely used in the aircraft sector, recorded strong rates of expansion for both exports and imports, mainly on advances in trade with the United States.

Foreign direct investment (FDI) in Canada slowed dramatically in 2008, rising just 2.8 percent versus double-digit rates the previous two years. The new investment came mostly from non-U.S. sources, as U.S. investment in Canada was flat. Total FDI in Canada rose to $504.9 billion at the end of 2008, up from $491.3 billion in 2007. This marked the first time that the stock of FDI into Canada surpassed the half a trillion dollar mark.

At the same time, Canadian direct investment abroad (CDIA) surged 23.6 percent ($121.8 billion) to $637.3 billion at the end of 2008. Some 68 percent of the increase was due to currency effects as the Canadian dollar depreciated against other currencies. Nonetheless, without the exchange rate changes, the stock of CDIA grew by $39 billion over 2008. Overall, the difference between outward and inward investment, which is Canada's net direct investment position, widened dramatically to $132.4 billion in 2008, up from $24.8 billion in 2007. 2008 also marked the first year that Canada became a net exporter of capital to the United States, as Canada's direct investment position in the United States exceeded U.S. direct investment in Canada.

With respect to the longer-term trends, as discussed in the information boxes in this publication, Canadian trade has been diversifying. Growth in Canadian trade with non-U.S. markets, for both exports and imports, has surpassed that of trade with the United States in every year since 2000, coinciding with an increase in the number of exporters to Europe and the Asia-Pacific region and an increasing share of sales by Canadian affiliates in non-U.S. locations, particularly in non-OECD markets. At the same time, fewer firms are exporting to the United States, and Canada-U.S. trade has become less reliant on intra-firm relationships, as the share of Canada-U.S. intra-firm trade has been on the decline over much of the present decade.

Special Feature: Canadian Trade Opportunities in Emerging Markets

Advances in information and communications technologies are enabling increased global economic integration. This creates opportunities for emerging and developed countries to generate long-term growth, which will return in force when the current economic crisis abates. The potential for growth in these countries driven by technology-based productivity improvements has barely been tapped into so far. Resulting enhancements in output and efficiency and the access to relatively open global markets will, under conditions of good economic governance, ensure consistent per-capita income growth and enable convergence between rich and poor nations, reducing imbalances in international income distribution.

This process will be accompanied by tremendous growth in the importance of the emerging world. One-tenth of a percent of the import market of the BRIC countries alone is estimated to be worth $29 billion in 2038, so Canada's share of these markets matters. Econometric modelling of Canadian merchandise exports to the emerging world shows that Canada is exporting some 42 percent more than expected to an average emerging or developing economy, after taking into account trade-influencing factors such as GDP and distance from Canada. Exports are particularly high to East Asia (China, Malaysia, Indonesia), but are lower than predicted to some major destinations such as Brazil and India.

Further insight into Canadian export performance in emerging markets is gained through the framework of comparative advantage analysis in 15 key emerging markets across the globe. Our global competitiveness benchmark outside of the United States is noted for strength in agri-food, metals and minerals, wood and paper, and aerospace sectors; local differences from this pattern are interpreted as over- or under-exports to these destinations. Most of the advanced manufacturing sectors are over-exporting to the emerging market destinations relative to the global benchmark. Aerospace is the one manufacturing sector that generally under-exports to the selected emerging markets, due to our strong performance in aerospace in advanced economies. Overall, these results suggest that emerging markets will play an important role in the future of Canadian manufacturing.