10 keys to understanding the economy in 2017

April 2017

Every year, Richter hosts its Economic Forecast Forum in Toronto and Montreal, during which a leading economist is invited to present his or her outlook for the Canadian, U.S. and global economies. This year, Benjamin Tal, Deputy Chief Economist at CIBC, captivated the audience with his valuable insights for the year ahead. Here are 10 keys to understanding the economy in 2017, as presented by Mr. Tal.*

1- There is a job problem in Canada and the U.S.

An analysis of the unemployment rates and wage increases in recent years paints a clear picture of the situation: there is a job problem in North America. “The long-term unemployment rate is now higher—eight years after the recovery [from the 2008 financial crisis]—than what it was at the peak of the 1991 recession. Something is going on,” notes Mr. Tal.  

According to Mr. Tal, the participation rate in the job market is declining. Today, there are more people collecting disability benefits than there are production workers in the U.S., which is a worrying trend.

Canada is also showing signs of a similar problem, with the quality of wages in the country dropping, and the number of workers making below-average wages increasing.

2- The job problem does not have a solution

According to Mr. Tal, this deterioration of the employment market is part of a lasting trend: “The elephant in the room is that this problem simply does not have a solution.” Hence, Donald Trump, who was elected on the promise of bringing jobs back to the U.S. but is “fighting something that he cannot solve.”

The drop in job market participation cannot be attributed to the globalization of the economy alone, as activity in the U.S. manufacturing sector has been declining since before China was a member of the World Trade Organization. The primary cause of this problem is a structural shift in the economy: “For every job lost to trade we lost eight to automation and technology. We cannot reverse it,” explains Mr. Tal.

The increase in automation has led to a mismatch in the labour market worldwide, such that people do not possess the skills needed to fill the jobs that are available: “We have people without jobs and jobs without people.” This problem affects even the most educated countries. According to the Organization for Economic Cooperation and Development (OECD), Canada, for example, is the OECD country with the highest number of people in university, but also the country with the highest number of educated people living in poverty. “We simply cannot translate those degrees into jobs,” emphasizes Mr. Tal.

3- The potential growth of the global economy is down

According to Benjamin Tal, the global economy is actually improving, as 2017 should be more prosperous than 2016. This should not come as a surprise, since central banks are injecting money in the economy, and major economies such as Japan and China are lowering interest rates. The improvement in the global economy is a direct result of these measures.

However, the long-term trajectory of the global economy is not as promising. “This cyclical improvement is artificial. The big story that every investor and company has to understand is that the potential growth of the global economy has been going down,” says Mr. Tal. The decrease in potential growth is attributable to two factors: aging demographics and the slowdown of productivity improvements. According to Mr. Tal, the technologies created today are not adding to productivity in the same way that we have seen before: “Facebook is not adding to productivity to the same extent as the Internet did.”

4- The Eurozone is vulnerable

“Economically speaking, the euro is doing fine, but the eurozone is vulnerable because of the political situation,” explains Mr. Tal. With elections coming up in France, Germany and the Netherlands, we could be in for a drastic change in the political landscape, which would impact Europe’s economy.

5- Brexit negotiations will take forever

According to Mr. Tal, UK Prime Minister, Theresa May, is in a difficult situation regarding the Brexit negotiations: “It is not easy, because she wants free trade but does not want to pay, which is not going to happen. The negotiations with the European Union will take forever.” This situation will leave the United Kingdom’s economy and currency vulnerable in 2017.

6- China needs more consumption, not investment

The Chinese stock market turbulence of 2015–2016 marked a turning point in how the market perceives this country’s economy. “Until about a year ago, the market was operating under the assumption that the Chinese authorities have the monetary might, the fiscal might and the political ability to deal with whatever happens. Then in August 2015, the stock market in China went down. […] This was a crisis of credibility because the market lost faith in the communist party,” says Mr. Tal.

In response, China has been trying to increase consumer spending and decrease investment. “But now, credit is rising by 22% in China; 85% of it is going in real estate and the last thing China needs is another empty shopping mall,” says Mr. Tal.  

7- Energy is an interesting investment

According to Mr. Tal, one of the biggest stories in the energy sector is that of the Organization of the Petroleum Exporting Countries (OPEC)’s strategy. “OPEC wants to buy time, because they know that within 10 to 15 years, they will be less important because of the growth of renewable energy,” explains Mr. Tal. According to him, they have implemented a strategy to lower the price of oil in order to make investment in renewable energy less attractive. This strategy, coupled with the flexibility in U.S. production, will make it difficult for oil prices to reach levels at which Canadian production is profitable. This means that Canadian companies need to focus on improving their cost structures.

8- Trade: U.S. is at risk of losing, in a big way

Trump has stated he wants to favour an “America first” policy, which might include significant border tariffs. These could affect many countries that export to the U.S., but could also prove detrimental to the U.S. economy itself. “When we talk about trade, we talk about how much others will lose, but the U.S. will also lose, in a big way. The U.S. needs Mexico, its second largest trading partner, and China, which represents a very important market for the American automobile sector,” explains Mr. Tal. The Chinese market in particular is evolving, with a new generation of teenagers that have a higher propensity to consume than the average American teenager. Brand-name and high quality products represent a growing market in China, a market in which the U.S. has done well. “You start a trade war, you risk losing this emerging market,” says Mr. Tal.

9- Canada should be booming, but it’s not

With low interest rates and a weaker dollar, Canada’s economy should be experiencing enviable growth. “Our dollar went from parity to 70 cents. We should be booming! We are not,” says Mr. Tal. According to him, two reasons explain why the manufacturing sector is unable to leverage the present conditions into growth.

The first is that the period of parity between the Canadian and the American dollar caused a 10% reduction in our country’s manufacturing capacity. The parity period “was nothing more than an economic accident.” It resulted in a significant loss of market share to Mexico. “Now, we need to rebuild that manufacturing capacity,” says Mr. Tal.

The other reason is the slowdown in the U.S. manufacturing sector. “Seventy per cent of what we are selling to the U.S. goes to the manufacturing sector, and that sector is slowing down because of a strong U.S. dollar,” explains Mr. Tal.

10- Canadian real estate can reach a soft landing

“According to the numbers, we are in a real estate bubble. But if we dig deeper in the housing market, we see that we can reach a soft landing,” says Mr. Tal. The new regulations put in place by the government are designed to slow the market by pricing out first-time buyers, and they are achieving that effect in Vancouver and Toronto. “This will result in a higher propensity to rent and will create opportunities in apartment projects,” stated Mr. Tal.

*The information contained in this article are the insights and observations gained by Richter from the presentation given by Benjamin Tal at the Economic Forecast Forum. 

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