How Has Canada Been Going?

Oh Canada, America's presumptive 51st state has been in the news recently for a long list of problematic reasons. The resignation of a prime minister, some of the most unaffordable housing in the world, an increasingly complicated relationship with its only direct neighbour, largest trading partner and closest ally are all compounding within an economy that's not nearly as healthy as it was just a decade ago. Now of course Canada is still a high income advanced economy and the economic situation would need to get a whole lot worse before that changes, but it doesn't mean that economists are not paying very close attention to what happens here, because what happens here is probably eventually going to happen to a lot of other economies around the world. Canada just appears to be one of the first out of the gate. Unsustainable real estate speculation, resource dependence, an aging population and productivity stagnation all propped up by questionable immigration policies are not problems by any means unique to Canada, it's just embraced more than most other advanced economies and is starting to feel the side effects the hardest. Now before the doom and gloom Canada is also a great case study into the different ways that different economies realise the economic consequences of their actions. So what is the brief summary of Canada's current economic problems, is it possible to fix these problems, and of course what will happen to the economy if they can't? The internet has completely transformed the global economy, breaking down borders, connecting businesses and making information more accessible than ever. But ironically your access to the internet itself still feels different depending on where you are. 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In 2008, like most other major nations at the time, Canada's economy started taking an aggressive dive in the wake of the GFC. However thanks to a combination of a housing and financial market that wasn't quite as overheated as the USA, and resource exports to China, it was not hit as hard as the rest of America and Europe. The country did originally manage to not only bounce back from the crisis, but witness the similar resurgence in the following two years. What separates them is that nations like the USA continued to see unprecedented growth while Canada's ride wasn't nearly as smooth. In fact it started an extended period of stagnation. After the 2014 oil market crash Canada has continued to reveal a fairly long chain of troubling vulnerabilities, with a decline that's often been noted as one of the worst amongst developed economies. Among these vulnerabilities is one that Canada isn't necessarily dealing with exclusively, but it's become such a massive problem that it's almost come to define the country's economy, and that is of course housing. Aside from the obvious zoning laws and regulations, the country has made a series of mistakes that made its housing affordability uniquely horrible in comparison to other western nations, a lot of which can be attributed to lowered interest rates as well as how they view real estate as an investment. Of course lowering interest rates is a standard for countries in the wake of a crisis, if nothing else it's often used as a psychological tool to increase consumer confidence to avoid the death spiral caused by less borrowing, less spending and less investment. This on its own is stock standard counter-cyclical monetary policy, nothing that unusual. But it did cause a few problems specifically for Canada. For starters their housing market never really suffered as badly as the USA during the crash, because although it may be hard to believe now, lending and real estate investing was a lot more controlled in Canada at the time. Now that's a good thing by itself, but when the country lowered interest rates, largely in line with most other advanced economies around the world, it boosted a market that never really felt the correction in 2008. This has over time reinforced the idea that Canada sees housing both as an investment vehicle, one that's never really failed, and as a consumable good for people to, well, you know, live in. As more of the population bought into housing as a wealth building tool, price increases became not only inevitable, but politically desirable. For some perspective, if an economic good like a dishwasher doubled in value every five years that would be seen as an economic failure, especially now that modern products like this need to be replaced constantly. But when houses double in value the same way, a lot of the population in places like Canada see it as a great outcome because it materially increases their wealth. And yet this cultural demand has led to a situation where a majority of Canada's population are homeowners. So the country could have fixed these problems before they started, increased interest rates, tightened lending rules, and reduced tax incentives for home ownership and investment. But with a majority of the population owning real estate, it's put Canada in a bit of a political vice, especially considering that Canada's housing debt now exceeds its total GDP. Nobody wants to be known as the figure that put an end to the party. Of course, this is clearly not a sustainable system. The value of homes in Canada has seen dramatic increases, with prices soaring more than 300% over the past two decades, while median nominal incomes only increased by slightly more than 100% over the same time period. As a result, things are starting to change, and the unfortunate part is, the party is going to end regardless, with the nation witnessing more and more individuals living with their parents or relying on them to buy homes, which only worsens issues like intergenerational wealth gaps. This also only compounds with rising migration concerns, but more on that later. All in all, the Canadian housing market is part of a system that's unlikely to change significantly. Most people just aren't willing to stomach policy changes that make homes cheaper, because so much of their wealth is tied up in home equity, with little desire for their massive loans to be worth more than their quote-unquote biggest asset. But homes are honestly more of a symptom of Canada's deeper problem, stagnating productivity, and the subsequent loss of skilled labour that often follows. Standing as the United States' most logical peer, it might be surprising to discover that there is a significant difference between the productivity of the average Canadian and the average US citizen. Both share a large amount of cultural similarities in the realm of entertainment, common law, higher education and tech, but Canadians simply don't make as much stuff as the average American across the border. And while people might try to help dispel these differences when looking at something like work hours, where US citizens spend about 6% more time at the desk or on the assembly line, it's important to note that even when these work hours are adjusted, US citizens are still 30% more productive than their Canadian counterparts. Even looking at the two countries on a per-industry basis, Canada still lags behind, and the reason for this doesn't have to do with lazy workers or better working conditions, a lot of it boils down to investment. The US just diverts much more of its money into making its workers more productive. We dove into this concept two years ago, so we'll keep it brief, but to produce anything there are three major requirements for any country wishing to expand beyond its current state. Land, labour and capital. Labour is improved with things like a younger, healthier population and improved education. Land is more productive with natural materials and optimal locations like being near water reserves. And capital includes things like machinery or infrastructure that increase in value with each subsequent investment. It's the stuff that makes more stuff. Moreover, improving any of these factors will have positive effects on the other two. For example, improving capital in something like farming through modern fertilizers, genetically modified plants and mechanised equipment would make it more efficient, reducing waste and increasing crop yields from often limited acreage, while also reducing the required physical labour. This is more obvious in regular farming or manufacturing where they are using literal tools, but even something like technology development, which looks like people sitting idly in offices, relies a lot on technical infrastructure that is expensive to establish and Canada just doesn't compete. This investment in the USA is a lot more intense, which means they have better tools, more innovation and more dominant companies. And the fact of the matter is, Canada has been slowly slipping in many of the aforementioned areas for about 40 years. During this time natural resources, once contributing 26% of the nation's economy, now contribute less than 12%. Agriculture is at 5%, trending downwards to about 1%, while manufacturing is only contributing about half of what it was in the 1980s. Of course, this is a percentage, which means something else is taking its place. The Canadian economy is in the middle of a retirement phase, with two key developments that have changed the statistics over time. An ageing non-working population prioritising healthcare, accompanied by a vast majority of wealthy people pushing the system towards financialisation, investing their money into real estate. It's also why Canada's lost decade, or decades depending on the angle, has in many ways remained hidden from global scrutiny. For all of the sensationalised headlines about the housing crisis, most Canadians used it to create a formidable nest egg for themselves, especially in the wake of the pandemic, lowering delinquency along with a decrease in home supply keeping prices artificially elevated. And this has been a significant challenge, specifically when it comes to Canada's silent rivalry with the boisterous bald eagle. With an ageing population and general risk aversion, the Canada of today is very different from what it was even a decade ago. Industry has become more consolidated and less innovative. If investors are putting their money into Canada, it's going into Canadian housing rather than businesses that actually produce sustainable value add. If investors wanted to invest in the business, there would need to be a really good reason to pick Canada over the more business friendly, more financially established, and generally more innovative USA, and so far, the country just hasn't been able to provide that reason. This means businesses don't get as much funding, which means they're lesser started, and they have fewer tools, which means their workers can't produce as much, which means they can't get paid as much, which would be fine if Canada wasn't so damn expensive because of all of the investment flowing into real estate. What's worse is that with a pretty indisputable advantage in career opportunities, a lot of really talented people are moving to the US to access their world-class colleges and then just never going back. And this shows no signs of slowing as the latest census indicated a 70% increase in immigration over the last 10 years. And just like mortgage costs, the Canadian government has introduced policies to buffer brain drain, albeit with very mixed results. For one, in the past, the country has been able to hold this economic loss off with natural resources, but that's always a bit inherently unstable because it's dependent on the global market for those resources, and it's at the mercy of changing trade dynamics around the world. Then there's the other policy that Canada has embraced to combat the ongoing exodus directly, opening its doors to two different kinds of migrants. The first of which are wealthy migrants who, to be fair, come with a fair number of benefits. Initially, they have the potential to help the country through income taxes and consumption taxes and offer much-needed capital for diversification and even possibly improve relations with other countries that they came from, forming profitable ties. Of course, there are also a fair number of caveats. While wealthy migrants provide a much-needed cash infusion, it has the potential of pouring gasoline over previously controlled fires. The most obvious one being housing market distortion, where luxury living spaces like large homes and condos become even more unaffordable to pre-existing residents, many of whom have been saving for years. Also, while many of these migrants may invest in the economy, there's no telling what they will choose as a viable investment. Then there are the people moving to Canada for a better life and the opportunity to make their fortune. Obviously, this group doesn't provide the same capital inflows, but they do largely provide low-cost labour and all other jobs that no one else wants to do, at least not for the wages people are willing to do them for. This one, for many reasons, is much more complicated. Before the height of the pandemic, Canada had adopted a two-step migration model for workers. And there are a number of positives tied to this as well. Especially as Canada is losing young workers to the USA, this is the most immediate solution to make sure that certain roles get filled to support the ageing population. The other, slightly less politically correct point is that for Canadians that have already had time to build up wealth, having a ready supply of people willing to work will materially increase their quality of life, even if it's something as simple as having support staff or, yeah, you know, someone to deliver Uber Eats. This isn't unique to Canada, however, they held a sort of fail-safe policy where if unemployment exceeded 6%, they were no longer able to accept temporary foreign labour applications, with the exception of more remote parts of the country. This might seem a bit harsh, but these laws were in place to ensure that existing residents could still find jobs in times of hardship. It was also there with the express purpose of encouraging wage growth, on top of preventing exploitation from large corporations. But Canada has since brushed this off the table in an effort to compensate for stagnation. In other words, it's true that this has helped to keep the economy chugging along, but it's made housing more expensive and introduced a lot of competition into the labour market, which has been politically unpopular and has accelerated issues like brain drain, because talented workers can just move to the USA where they can earn more and will probably spend less on a house. Of course, this is all probably going to get worse as the immigration taps need to be closed, which is kind of like stopping drinking. Long term it's probably the right thing to do, but short term it's going to be one hell of a hangover. And as if this situation couldn't get any worse, the silent rivalry between Canada and the USA, well, it's no longer all that silent. It's difficult to tell if the 51st state conversation is a theatrical bluff, but the on again off again threats of tariffs, even if they are somehow never implemented, are enough to shake up the fragile industries the country is now reliant on more than ever. Now beyond the doom and gloom, there are ways that Canada can bounce back, it's really just a matter of what they choose to prioritise. For example, the Canadian infrastructure deficit is a real issue for them, and it's costing them over 200 billion US dollars to contain it. If government spending were diverted to making lasting improvements, it would encourage long term employment and opportunities to encourage skilled labour. One of the more subtle reasons why this has been harder to solve is Canada's governmental structure where cities bear a significant amount of the financial burden, effectively making a lot of these issues someone else's problem, while the population influx has created unprecedented strain. There's also the climate factor. The country has a harsh environment that's tough on infrastructure, compared to temperate dry economies things just fall apart faster in the cold than the wet. This only becomes more difficult when looking at the northern end of the country where the transport of materials is a major expense in and of itself. It's pretty much out of the question that Canada will surpass the US when it comes to incentives, but that doesn't mean that Canada isn't capable of slowing the outflow of its citizens by channelling money into better automation and industry tools, and by working to make more modest incomes go further, especially when it comes to housing. To their credit, they have started doing this recently, but their approach will need to be far more aggressive to make up for lost time. The only thing is, they have very little to spare. With a blistering increase in immigration, housing debt that surpasses its GDP, wealth disparity, cataclysmic brain drain and a temporary loss in leadership they can't afford, Canada's refusal to act preemptively means digging itself out of the hole is going to be twice as hard. Now, in a lot of concerning ways, the Canada of today has a lot of similarities with the Spain of two decades ago, a story that famously did not end very well. Now, nobody can predict the future, but you should be able to click that video on your screen now to see if you can spot the parallels. Thanks for watching mate. Bye.