Stephen S. Poloz
Vice-President and Chief Economist, Export Development Canada
SELLING CANADA TO A VOLATILE WORLD
Chairman: Ann Curran
Head Table Guests
Gareth S. Seltzer, President, TWS Private Management, Past President, The Empire Club of Canada; The Reverend Douglas Kramer, St. Philips Lutheran Church, Etobicoke; Randall Harwood, Director, International Business, Industry Canada; Archie Marshall, Vice-President, Commercial Banking, Western and Central Ontario, National Bank of Canada; Bonnie Winchester, Assistant Deputy Minister/President and CEO, Ontario Exports Inc.; The Hon. Senator James F. Kelleher, PC, Senate of Canada; Ken Shaw, National Editor, CFTO Television and Director, The Empire Club of Canada; Ruth Fothergill, Vice-President, Corporate Outreach, Export Development Canada (EDC); Robert Fung, Chairman, Toronto Waterfront Revitalization Corporation and Member, EDC Board of Directors; and Lili Sham, Vice-President, National Accounts Ontario, National Bank of Canada.
Introduction by Ann Curran
These are uncertain times--a war in Iraq, international terrorism and the outbreak of SARS. Yet life and business must go on. Which leads us to the question: "How do we sell Canada to a volatile world?About one-third of all income earned in Canada is generated through international sales. Yet Canada has been an oasis of prosperity through the global turmoil of the past two years. Can this continue? How will the next international storm affect us? Mr. Poloz will offer his latest views on the global economic outlook and its implications for interest rates, exchange rates and the key sectors of the Canadian economy.
Stephen Poloz joined Export Development Canada (EDC) in September 1999. As EDC's Chief Economist, Mr. Poloz leads a diverse risk-assessment group comprising six departments: market and economic analysis, country risk assessment, political risk assessment, technical advisory services, environmental advisory services and the corporation's information centre.
Prior to joining EDC, Mr. Poloz was Managing Editor of the International Bank Credit Analyst, a monthly global investment research publication that is read in more than 80 countries. Before that, Mr. Telex spent 14 years with the Bank of Canada, occupying a number of senior positions including Chief of the Research Department. During his tenure with the bank, he was a visiting scholar at the Economic Planning Agency in Tokyo, as well as at the International Monetary Fund in Washington. Mr. Poloz earned a PhD and an MA in Economics from the University of Western Ontario, and a BA in Economics from Queen's University. He has published extensively on a wide range of economic issues and has served on the editorial board of the Canadian Journal of Economics and on the Executive Council of the Canadian Economics Association.
Mr. Poloz will be sharing EDC's outlook for the global and Canadian economy over the next 16 to 18 months.
Ladies and gentlemen, I give you Mr. Stephen Poloz.
Is it just me, or has the world suddenly become a riskier place to do business? I know one thing for sure--economic forecasting has become a brutal business.
It has been one big economic shock after another, starting with the events of 9-11. We had no sooner put that behind us when we discovered corporate malfeasance, which caused trillions of dollars in wealth to evaporate. Then the war drum began to beat in Iraq, making the outlook uncertain again. And when the war came, it actually had to compete for the headlines with another big story that came from nowhere--SARS. Now the Koreas are back on the front burner.
The lesson? These days, we need to deal with a much higher level of uncertainty in running our businesses. It is as if we are playing baseball, and the field has suddenly become twice as big as it used to be, and we have to be prepared to play anywhere the action takes us.
Making an economic forecast in such a situation is a brave or perhaps foolhardy thing. Even so, it is less daunting than the challenge Canadian companies face every day in selling Canada to such a volatile world.
And sell to the world, we must, if we are to grow our businesses. The global marketplace is 50 times the size of Canada's domestic market. That's a big prize--one worth taking risks for and one worth innovating for.
Globalization is a lofty term for something quite simple: products are divided up into their components, those components are manufactured around the world, each in the best possible place, and then the parts are brought together into what we can call a global product.
Canadian companies that innovate in this way increase their productivity and profit margins. They also discover a basic truth: they must do a lot more international trade and cross-border investment just to make their product. Then, they must do even more international trade to get the product to the buyer.
The fact is that we are hooked on international trade, and Canada is not alone. The entire world is becoming more and more dependent on trade for economic growth; we must trade faster just to stand still. Every dollar of income created in the world today relies more on international trade than ever before. And because those global supply chains are distributed around the world, we also must invest more in foreign countries to produce each dollar of income.
Isn't it ironic that, just as we enter the reality phase of globalization, the world has suddenly become a riskier, more complex place to do business? Increasingly, borders are becoming something more than just a line on a map. Although people have bought into the benefits of liberalized trade, now they see that new openness transforming itself into a security threat. Security trumps trade--no surprise there.
Today, people are preoccupied with war, terrorism, SARS, the Koreas, and their potential effects on the economy. And there is no need to debate it; the global economy has stopped in its tracks in recent weeks. Uncertainty makes people hesitate to make big decisions, and the global economy has paused.
Describing this as a pause of course suggests that the world will return to a normal growth track when the uncertainty eases. Whether that recovery is automatic depends greatly on how long the pause turns out to be. At some point, a pause becomes a postponement and then it becomes a reconsideration and then, finally, it becomes a whole new plan. That is when the pause can take on a life of its own; it becomes a negative dynamic process, and the economy can slide into recession.
But we have not reached that point, so far. Our analysis of the global economy indicates that, setting aside the current level of uncertainty, the global glass is half full, not half empty. The seeds of recovery remain in place, and left to develop they will grow. But regardless whether the best description is "half full" or "half empty," the word "half" goes to the heart of the matter: the world is operating well below its potential, and it is clearly vulnerable to more bad news.
Nevertheless, as the uncertainty due to war and SARS dissipates, we expect the world economy will get back on track. The pause in the first half of the year will give way
to modest growth, which should average 2.9 per cent for the year. This will make 2003 feel very similar to 2002 in terms of growth, but we should end the year on a more positive footing.
In this global context, Canada will remain a solid performer, with growth of 3.2 per cent forecast. World economic growth will be led by non-Japan Asia, which will see growth of around 6 per cent. U.S. growth should be about 2.2 per cent. Europe will be lacklustre, Japan even more so, but South America will gradually get back on track.
Canadian exporters have weathered two years of declining sales in a row, for the first time in 50 years. After a difficult start, 2003 promises to be a year of higher export sales, with 3-percent growth forecast, excluding energy exports, which will rise much more due to higher prices. Key sources of strength will be traditional resource sectors, such as chemicals, ores and metals. Moderate growth is expected for agri-food, forestry and export sales of equipment. Auto exports face a soft outlook, while aerospace exports are likely to decline again this year.
The gradual dissipation of uncertainty will mean higher interest rates. Given our relatively strong economic performance, Canada's interest rates are likely to lead the way, followed by the U.S. and then Europe. Further, as the world falls into better balance, with positive growth everywhere, the U.S. dollar will resume its downward trend against most currencies, including the Canadian dollar. The Canadian dollar can be expected to trade in the high 60s against the U.S. dollar through most of 2003, but to settle at 70-71 cents by mid-2004.
Now many people will disagree with this analysis, or at least worry that some of our assumptions will be wrong and deliver an even more difficult business environment. I am the first to admit that my level of confidence is lower right now than it usually is. So let me turn now to an examination of the key issues that lie behind this forecast; the issues you will no doubt be debating with others over the barbecue this weekend.
What will SARS do to the world economy? SARS is clearly contributing to the current pause in global economic growth. A lot of travel is being cancelled and people who are quarantined for a week or two do not produce much GDP. They don't work, and they barely shop. Obviously, the effects are impossible to quantify at this point.
The epicentre of the SARS shock is in Asia, which unfortunately also happens to be the world's only growth locomotive right now. In fact, our forecast is that half of all the growth that we see in the world this year will come from non-Japan Asia. The region has largely recovered from its financial crises of 1997-98, and the economy has changed very fundamentally We have grown accustomed to thinking about Asia as a big manufacturer that exports goods to North America and Europe, but that situation is changing. In fact, these days, some 75 per cent of Asia's exports are to other countries in Asia. This reflects the emergence of the Asian consumer; evidence is most clear in China, India, South Korea and Thailand.
We assume that SARS will lead to some cancellation of economic activity, but mostly postponement. We must bear in mind the possibility that it could blossom into something with much bigger economic implications. But even if the loss of activity rivals that after 9-11, it will not be sufficient to derail the Asian growth story.
Is real estate the next bubble to explode? The collapse of the tech equity bubble three years ago has everyone on the lookout for the next bubble. Real estate prices have gone up a lot as low interest rates have fed demand. But I see the surge in real estate as more fundamental than that. A lot of people were burned badly by the collapse in stock prices following the tech wreck, and I think a lot of them have turned their back on stocks as an
investment. Furthermore, we live in troubled times--terrorism, war and the like--and that is making people cocoon, feather their nests, and spend more time at home with their families.
Ordinary people will not come back to stocks just because the stock market starts to stabilize. I think they will stick with housing as a preferred investment for a long time. This was true in the 1970s and it took all through the 1980s for confidence in equities to return. The implication is that the housing market might cool off a little, but I do not see it as a bubble ready to explode.
How long can the U.S. consumer keep spending? U.S. consumer confidence has declined to its lowest level since October 1993. That sounds grave, but consumer confidence has never been the greatest predictor of consumer behaviour. The year 1993 was actually a pretty good one for U.S. consumer spending. Consumer confidence has been dropping basically since 9-11 and consumption spending has continued to grow.
The reasons for this are pretty simple in my mind. Income is still growing in the U.S., and the main reason why confidence has fallen is because of uncertainty related to terrorism and war. Are these the sorts of risks that make you want to save your money? In fact, I think spending money, especially on things for the home, makes people feel better in such stressful times.
I think the U.S. consumer is going to continue spending money at a regular pace, keeping the economy on a slow-growth path. Consumers probably went on pause at the outbreak of the war. If you spend a lot of time glued to the television and the weather is bad, you do less shopping. But much of that can come back when the situation normalizes.
Is the rising Canadian dollar going to choke off our export business? Our global forecast is consistent with a rising Canadian dollar. Because Canada is so dependent on the world for its livelihood, the Canadian dollar tends to be a barometer of world economic health. When the world is in trouble, the Canadian dollar weakens to help us weather the storm.
Since 1996, we have experienced one crisis after another, and the U.S. dollar went up each time as it fulfilled its role as safe haven. The total increase was about 30 per cent. We have now begun a slow healing process, and a characteristic of that process will be a better balance of global economic growth, a wider spread of investment around the world, and the dollar will decline against most currencies. That includes the Canadian dollar. Assuming the world gets back to normal during the next year or so, the Canadian dollar should work its way up to around 70-71 cents against the U.S. dollar.
With the Canadian economy so far out in front, our interest rates rising, plus the U.S. dollar looking so vulnerable, we have most of the characteristics that in the past have caused the Canadian dollar to move beyond its fundamental value. This is in fact what happened in 1991. .
Accordingly, this is a risk that we need to prepare for. Our base case assumes that the dollar will continue to fluctuate in the high 60s this year and drift higher next year, but it could move up above the 70-71 cent range this year, and then come back down to that value later as the rest of the world catches up to us. Such a scenario would put the squeeze on some Canadian exporters, no doubt about it, because it would happen before the world economy returned to full strength. It would mean less growth in our exports, and slower growth for the Canadian economy.
To sum up, our analysis is that the world will return to its recovery path once the geopolitical situation begins to normalize, but that will still mean that 2003 will be a challenge for Canadian exporters.
Even as geopolitical risks recede, others will remain. Security issues are turning borders into something more than just a line on a map. Trade liberalization could stall.
Global trade and investment, the engines of economic growth, are unlikely to return to their former glory days anytime soon, which means that trend growth in the world economy will be less than what we became accustomed to during the 1990s.
Meanwhile, sluggish growth means that financial stresses will remain high, causing bankruptcy statistics to stay grim. At EDC we see these stresses first-hand. Last year, even though Canada's exports declined, EDC's business grew by about 20 per cent, as many more companies sought out our risk-management services, especially small companies. EDC facilitated over $50 billion in international transactions on behalf of over 7,000 Canadian companies, over 90 per cent of which are small or medium-sized.
The bottom line? Dealing with global uncertainty is difficult, but we may as well get used to it. No one said that 2003 would be easy for Canadian exporters. Our forecast theme six months ago was "Rough Crossing" and the world has certainly lived up to that billing. Our theme this time is "Recovery Interrupted." Conditions will improve later this year, and 2004 should be a solid one for international business.
The appreciation of the meeting was expressed by Ken Shaw, National Editor, CFTO Television and Director, The Empire Club of Canada.