Consumer Spending Plays Dominant Role in GDP
Consumer spending is 70% of U.S. Gross Domestic Product (GDP) and about 55% to 60% of Canada’s GDP. There is a symbiotic relationship between consumer demand and costing and pricing that runs throughout the economy. This report takes a look at some of the key issues.

There is a straight line progression that moves between four of the economy’s key economic indicators. Employment growth plays a crucial role in income growth, which drives retail sales and translates into personal consumption expenditures in the national accounts.

A Good Benchmark Figure for Retail Sales is +5.0%
Monthly retail sales become a good proxy for what is happening in terms of overall consumer spending (which is a figure that is published quarterly.) There is an easy-to-remember and easy-to-understand benchmark figure for retail sales, which is +5.0% year over year. This indicates good underlying strength in the economy.

The explanation is as follows. If retail sales are increasing at 5% year over year and the central bank’s inflation target of about 2% is being met, then real spending by the consumer is around 3%. Since consumer spending is such a large part of total output, this helps the economy move forward at a quite-solid pace. (For example, 3% GDP growth in any given year is considered pretty good.)

Two Factors Drive Consumer Spending
What drives consumer spending? There are two major factors to take into account. There is the matter of disposable and/or discretionary income on the one hand — i.e., the ability to fund expenditures. Second, there is the matter of the availability and consequent pricing of the goods that are in demand.

The first determinant relates to available spending capacity. In Canada, recent personal income tax cuts by some of the provinces and the federal government, as well as the scaling down of the Goods and Services Tax (GST) in two one-percentage-point stages, from 7% to 5% (on July 1, 2007 and January 1, 2008), is helping to stimulate demand. In the U.S., specially-legislated tax rebate cheques will be mailed out to individuals in May as part of a $160 billion stimulus package. Lower interest rates are also helping, as the U.S. Federal Reserve is taking drastic action and the Bank of Canada is following the fed’s lead on a downward path.

However, acting to restrain income growth is the slowdown underway in new job creation. This is already quite noticeable in the U.S. In Canada, it will result as a side-effect of the U.S. slowdown/recession (i.e., job losses in export-dependent manufacturing) and the fact that the pool of available workers has been greatly reduced, given that the unemployment rate is at a 30-year low.

Reduced residential real estate activity — far more pronounced in the U.S. than in Canada — will cut into consumer spending as well. So many of the dollars that are spent in the marketplace are on items for the home, from furniture and appliances to a host of renovation products.

The Pricing of Consumer Goods
Beyond their homes, what do people spend their money on? Some of the major items would be food and beverages, clothing, computer equipment and transportation. What’s happening to prices in each of these areas? The following are both Canadian and U.S. numbers based on the latest Consumer Price Index measures. Remember that, due to currency movements over the last several years, import prices have been dropping in Canada while they have been increasing in the U.S. This accounts for some of the differences between the two countries.

On a year-over-year basis, food and beverage prices are +1.4% in Canada, but +4.3% in the U.S. Clothing, footwear and other apparel is -2.1% in Canada and -0.2% in the U.S. These low numbers relate to cheap imports from offshore in both countries. Transportation prices are +3.8% in Canada and +9.4% in the U.S. This category includes vehicle prices, which are generally restrained in both nations, and the price of gasoline, which is +20% in Canada and +34% in the U.S.

The price of computer equipment, due to technological advances and some currency changes, just keeps dropping (-17% in Canada and -12% in the U.S.). This is a retail sales category that is more price-sensitive than some others. Health and education cost increases in Canada remain low, due to a high level of government involvement, whereas, in the U.S., they are increasing near or above the overall inflation rate (+4.3%).

Latest Retail Sales Figures
It remains to take a look at the latest retail sales figures in both countries. There is a significant difference in reporting dates between Canada and the U.S. Retail sales figures are a month ahead, south of the border. Year-over-year actual retail sales in Canada in December 2007 were +5.2% and the 3-month smoothed figure was +5.9%. Theses figures remain quite positive with respect to the previously mentioned +5.0% benchmark figure. In the U.S., weakness has already shown up, with a year-over-year three-month smoothed figure for retail sales of +4.4% and an actual figure of +3.9% in January 2008.

Wholesale trade figures are usually published a week or two ahead of retail sales. The wholesale numbers are often an advance indicator of what to expect from retail sales, a month or two down the road. This is not propitious for Canada since wholesale sales plummeted in the latest month. They were -2.9% month-to-month in the latest period.

The bottom line is that the consumer has grown a little weary in both economies. Plus, the uncertainty and negative talk about financial markets, housing markets and the economy generally is causing a more conservative streak to emerge. This alone, will slow economic growth this year.

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