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Canada's State of Trade: Trade and Investment Update 2012

Executive Summary

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2011 was a challenging year for the global economic recovery. After a strong rebound in output and trade that took place in 2010, fueled by inventory restocking, government stimulus and easy monetary policy, growth was expected to be slower in 2011. However, numerous adverse shocks made the slowdown worse than it should have been and also clouded the economic prospects for the year 2012 in several regions.

The eurozone crisis was the chief agent of uncertainty in the global economy in 2011. Growing fiscal stress and increasing uncertainty over the future of the European Monetary Union caused output in the eurozone to contract in the fourth quarter. The focus of the crisis shifted from the relatively small Greek economy to the large global players—Spain and Italy. As markets called into question the sustainability of their fiscal path, sovereign yields have increased, and the perceived risks associated with holding their sovereign debt have increased as well. This raised the degree of risk in the financial system, led to tightened credit conditions, lowered confidence and raised the overall level of uncertainty in the global economy. As several eurozone countries slipped into recession at the end of 2011, contagion from Europe spread through strong financial and trading links between this region and the rest of the world.

Generally, recoveries following financial crises are weaker and last longer, and this one is no exception. As governments in most of the advanced world shifted stance from stimulus to fiscal consolidation, private and business debtors were still deleveraging. As a consequence, private demand and business investment did not pick up sufficiently, resulting in slow growth. Many governments faced fiscal pressures that made it difficult to address the high unemployment rate prevailing in most developed countries.

The year 2011 also had its share of natural disasters and unforeseen events. The Great East Japan earthquake cut short the recovery in that country, disrupted supply chains across the globe and severely impacted the global economy in the second quarter of the year. Floods in Thailand in the fourth quarter had a similar effect, dampening growth across Southeast Asia. Civil disorder in North Africa and outright civil war in Libya led to curtailment of many economic activities in that region and raised uncertainty about oil prices. Fears of the recession in the United States did not materialize, and the country did better than expected at the end of the year, but the political gridlock that called its credit rating into question has persisted, making effective economic governance difficult.

For the year as a whole, world real GDP grew by 3.9 percent in 2011, down from the 5.3-percent pace of 2010. The pace of growth in the advanced economies slowed down to 1.6 percent in 2011 from 3.2 percent in 2010. By contrast, growth in the developing world continued to be high, posting a 6.2-percent increase in 2011, following the 7.5-percent growth in 2010.

Among the developed economies, the Newly Industrialized Economies of Asia continued to lead in real output growth, posting a 4.0-percent growth in 2011, although this was significantly slower than their 8.5-percent performance in 2010. Germany was the fastest growing major economy, with 3.1-percent growth. While historically modest, the 1.7-percent performance of the United States was in the end better than expected, as consumer spending and employment started to recover. Eurozone growth was 1.4 percent in 2011 following a 1.9-percent performance in 2010, with part of the region tipping into recession at the end of the year. France was the only major advanced economy to grow faster in 2011 (up 1.7 percent) than in 2010 (up 1.4 percent). Japan, which registered a 4.4-percent growth in 2010, was back in recession with a 0.7-percent contraction to its real GDP.

In the developing world, Asian economies drove the growth. Developing Asia’s economies expanded 7.8 percent in 2011. China led with 9.2-percent growth in 2011, following 10.4 percent in 2010, while India turned in a 7.2-percent performance in 2011 on the heels of 10.6 percent in 2010. Emerging Europe was the next fastest-growing region, with 5.3-percent growth, followed by Sub-Saharan Africa at 5.1 percent. South Africa, the largest economy in the latter region, slowed down to 3.1 percent in 2011. The Commonwealth of Independent States expanded 4.9 percent in 2011, with Russia growing at 4.3 percent, the same rate as in 2010. The Latin America and Caribbean region was next with 4.5-percent growth. Brazil’s economy, however, grew only 2.7 percent in 2011, considerably slower than the 7.5 percent posted in 2010. The Middle East and North Africa region, afflicted by popular unrest and internal tensions, posted the slowest growth of all the developing regions, at 3.5 percent.

As the recovery in the global economic and trading picture continued, albeit unevenly, the real economic activity in Canada expanded by 2.5 percent in 2011, after posting a 3.2-percent performance a year earlier. Growth in 2011 was largely driven by domestic strengths: strong private demand, stable financial system and booming business investment, while the second-quarter contraction in real GDP reflected largely a drop in exports as a result of external shocks. Growth slowed again in the last quarter of the year due to the resurgence of the eurozone crisis. All provinces and two out of three territories reported real economic growth in 2011. All major expenditure categories advanced on the year, with the exception of net trade. Inflation rose at a 2.9-percent pace in 2011, an increase from 1.8 percent in 2010, but excluding the most volatile prices resulted in a core inflation of just 1.9 percent in 2011. The Canadian dollar declined slightly against the U.S. dollar between January 1, 2011 and December 31, 2011, although its average valuation during that year was about 4 percent higher than in 2010. The employment picture improved in nearly all regions, with almost 200,000 net new jobs created during the year. While the unemployment rate improved only 0.1 percentage point during the year—from 7.6 percent in December 2010 to 7.5 percent in December 2011—the average for the year as a whole declined more substantially, from 8.0 percent in 2010 to 7.5 percent in 2011.

The volume of world trade continued to expand in 2011, but at a much slower pace than in 2010 as most of the recovery to prerecession levels already took place. World trade grew 5.0 percent in 2011 in real terms. Nominal trade values expanded 20 percent in 2011 due to rising resource prices. Real export growth in developed economies was stronger than expected, reaching 4.7 percent in 2011, while the developing world recorded an increase of 5.4 percent.

In Canadian dollar terms, Canada’s exports of goods and services to the world expanded 11.8 percent in 2011. Goods led the growth at 13.0 percent and services advanced 5.0 percent. On the import side, imports of goods and services advanced 9.4 percent, with growth in imports of goods at 10.2 percent and growth in imports of services at 5.8 percent.

By sector, exports in six of seven major goods sectors expanded. Exports of energy products led the increase in total exports, with increased exports of industrial goods and materials following closely. A volume driven increase in machinery and equipment exports was welcome news as it arrested a three-year decline. On the import side, expansion was driven by more imports of energy products; industrial goods and materials; and machinery and equipment.

Both exports and imports of services registered highest-ever levels. Both exports and imports of transportation services expanded rapidly in 2011, and the continued strength of the Canadian dollar in 2011 maintained a favorable climate for Canadians vacationing in and visiting foreign countries, driving the increase in the imports of travel services. The continuing growth in exports of commercial services extended Canada’s trade surplus in that category into its second year.

Outflows of Canadian direct investment during the year grew 13.8 percent in 2011. Financial flows were directed largely towards the United States and the EU, and away from the other OECD countries and the rest of the world. FDI inflows into Canada went up by two thirds, largely due to increased inflows from the EU.

The stock of Canadian direct investment abroad grew 7.0 percent (up $44.6 billion to $684.5 billion), largely caused by changes in currency valuation. Investment expanded most in traditional sectors of interest to Canadians abroad—finance and insurance; and manufacturing. The stock of foreign investment in Canada expanded at a slower pace (up $22.4 billion to $607.5 billion), with most of the increase in the manufacturing sector. Consequently, Canada’s net direct investment asset position expanded to $77.0 billion in 2011.

Taken as the sum of all of its components, Canada’s current account deficit shrank by $2.6 billion in 2011, as a result of a strong $10.4-billion improvement in the goods trade balance. The deficit for every other component of the current account widened, although not enough to overcome the strong performance of the goods trade. The services trade deficit widened by $1.9 billion, investment income deficit by $4.6 billion and the current transfers deficit by $1.3 billion. The resulting improvement was from a $50.9-billion deficit in 2010 to a $48.3-billion deficit in 2011, which marked the third straight current account deficit for Canada.

Special Feature: International Trade and Its Benefits to Canada

It would be very difficult to imagine a world without international trade for the average Canadian. International trade enriches our lives in so many ways and through so many direct and indirect channels that it would be virtually impossible to disentangle its effects or to precisely measure the innumerable benefits and conveniences it has brought. As trade is liberalized, markets are expanded for producers, while new products and competition are introduced into domestic markets. The resulting allocation of resources toward the most efficient firms increases the economic well-being of society.

Some of the benefits exports provide to Canadians are straightforward. At the most basic level, they allow us to sell our goods and services and exchange them for foreign goods and services. They also help to support jobs in Canada, directly to those producing the goods and services, and indirectly to those in supporting activities to the producers of Canadian exports. Indeed, one in five jobs in Canada depend on exports, either directly or indirectly.

However, exports also provide other benefits that are not as readily apparent. For example, exports mean added production beyond that produced for the domestic market, which allows for economies of scale in production and lower average costs for producers, leading to lower prices to purchasers. Competing in export markets also means seeking out efficiencies and being innovative in all aspects of business. Rather than trying to produce many products, firms tend to focus and specialize in products or services where they have an advantage, resulting in an international division of labour and increased economic welfare. This also drives up the productivity of the firm and helps to increase the prosperity of the nation. Rising productivity allows firms to pay higher wages. Firms that rise to the challenges of the export marketplace increase their production volumes and become larger. Following conclusion of the Canada-U.S. FTA, almost all Canadian manufacturing sectors exhibited some form of specialization, for example, by reducing the diversity of their output or switching from multiple-plant to single-plant operations. The ensuing efficiencies boosted Canadian manufacturing productivity by 13.8 percent, a remarkable trade-related achievement. Moreover, these exporting firms pay their employees a wage premium that cannot be explained after taking into account differences in relation to non-exporting firms.

As a small economy, Canada produces only a fraction of the goods and services it consumes and imports the rest. In a world devoid of international trade, it would be unrealistic to think that a country like Canada could make the necessary investments to produce the range of products and services it presently enjoys. In other words, our access to a broad variety of machinery, computers, and communications technologies, and to travel and entertainment, to name but a few, reflects our ability to sell Canadian-made goods and services in international markets. Open trade increases the variety of products available to Canadians and introduces new Canadian products to external markets; this presents both new trade opportunities and new varieties to Canadian and foreign markets. Trade liberalization also impacts a firm’s pricing decisions by reducing mark-ups of price over costs, which helps to lower inflation in the country and keeps more money in the pockets of Canadian consumers.

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