In traditional economic cycles, expansion phases overheat, leading to rapid wage and price increases. These are corrected through high interest rates that bring economic growth to a halt for a while. The current slowdown is partly the result of some of these elements at an earlier stage in the cycle, but Canada’s current dilemma is also due to a number of curious, and perhaps unique, circumstances.

I would say that there are three major aspects to Canada’s current economic slowdown. The first two of these have both a currency component and a U.S. slowdown/recession component.

1) Weakness in the manufacturing sector. This began with the rise in value of the Canadian dollar and the consequent drop in export sales to the United States. However, it has now spread across a wider-range of manufacturing, with the prospect that this will become even more of a problem due to point 3). Much of non-auto manufacturing is destined for residences (e.g., appliances, carpets, home reno products, etc.). Capacity utilization rates in Canada in the first-quarter of this year were the lowest in 15 years.

The auto-production component of Canada’s manufacturing sector has fallen victim to the U.S. slowdown/recession. U.S. consumers aren’t buying autos, including those from Canada, because they are under assault from high gasoline prices, falling home prices and shaky job prospects.

2) Canada’s foreign trade in services is dragging the economy down. Much of this relates to tourism and business travel. Visits by Canadians to the U.S. have been strong for a while now, but travel in the other direction (i.e., Americans coming to Canada) has fallen off dramatically. Part of this is explained by the long-term increase in value of the loonie versus the greenback. But adding to this are new security measures at the border and the requirement for passports or other legal documentation of citizenship to return to the U.S. Year-over-year employment in accommodation and food services in Canada is currently 0.0%.

3) Fatigue in Canada’s residential markets. Exceptionally strong housing starts in 2002 through 2007 (223,000 unit-starts per year on average), a period of six years, is causing an expectation of softening in demand as 2008 unfolds further. Existing home sales have already exhibited some weakness, although some of that was due to really inclement weather at the start of the year.

Nevertheless, the factors that will rein in housing include high home prices in some key markets, a moderation in between-province population shifts (i.e., fewer fellow-Canadians moving to Alberta) and the fact that much of first-time homebuying demand has already been satisfied. When residential starts ease, this has ripple effects on retail sales and, following the linkage backwards, non-auto manufacturing, as stated above.

Let me elaborate on that last point. The fact is, the economy is a big spinning wheel of cause and effect. The prime engine is job growth. Employment increases lead to income gains that drive auto demand, home demand and retail sales. All three of these are answered by manufacturing and service sector activity. In turn, this leads to more job growth. At this present time, manufacturing and some aspects of services are depressing the outlook for jobs and this causes the whole whirring contraption to break stride.

Alex Carrick

Find Canadian construction-related economic articles in Canadian Construction Market News and in the Economic Outlook section of Daily Commercial News.

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