By Ted Carmichael
RBC’s B.C. president Martin Thibodeau told BIV that his bank plans is to keep most HSBC Bank Canada corporate head office jobs in Vancouver if it closes deal to buy that bank | Chung Chow
B.C.’s economic growth is showing signs of slowing as the province battles headwinds that heighten the risk of a recession.
Increasing diversification could be B.C.’s ace in the hole.
The province has long had a more diversified economy than Alberta, but its level of diversification among provinces has been middling – fifth out of 10, according to data collector BC Stats.
Fast growth in sectors such as technology and film production, however, has helped resource-rich B.C. diversify its economy, hedge against commodity-price downturns and be better able to weather adversity.
The Economic Forecast Council, a 13-member council of private-sector forecasters from throughout Canada, anticipates that the province’s economy will slow to 0.4-per-cent gross domestic product (GDP) growth in 2023, down 2.4 percentage points from 2.8-per-cent growth in 2022, and down 5.7 percentage points from 6.1-per-cent growth in 2021.
With that kind of economic slowdown, it is not unreasonable to expect that the province could slightly underperform expectations and experience two consecutive quarters of GDP declines – the standard definition of recession.
Businesses continue to grapple with the effects of the Bank of Canada rapidly hiking its policy interest rate to 4.5 per cent. Banks tend to lend money at approximately two per cent more than that rate.
Business loan growth in B.C. remains strong but is slowing.
Royal Bank of Canada (RBC) (TSX:RY) regional president for B.C. Martin Thibodeau told BIV that the value of his bank’s outstanding business loans in the province increased 17 per cent year over year at the end of March. In March 2022, the annual business loan growth rate was 20 per cent.
One wildcard for the economy could be the B.C. government’s steadily climbing debt.
S&P Global in mid-April downgraded B.C.’s credit rating to AA from AA+, and while the credit-rating agency kept the province’s short-term issuer credit rating stable at A-1+, it remains to be seen how a lower credit rating and interest rate hikes will affect the size of payments on the province’s more than $107 billion in taxpayer-supported debt.
“B.C.’s credit rating is still extremely strong [… but] the cost of money is more expensive today than a year ago,” Thibodeau said.
B.C.’s economy has always relied heavily on natural resources.
Energy products comprise the province’s biggest category of exports, at 37.5 per cent, according to BC Stats. Other commodity exports include wood products (17.1 per cent), metallic mineral products (9.6 per cent) and pulp and paper products (6.8 per cent). Combined, that adds up to nearly three-quarters (71 per cent) of total exports.
BC Stats categorizes metallurgical coal as an energy export, even though it is mostly exported to China to make steel. It comprises more than half of B.C.’s overall energy exports.
In the past decade, the fastest-growing energy export has been natural gas.
Non-resource-based B.C. exports include machinery and equipment (9.9 per cent), agriculture and other non-fish products (seven per cent), fish and seafood (2.4 per cent) and fabricated metal products (2.8 per cent).
Statistics Canada estimated that, in 2021, about a quarter of B.C.’s economic production is based on goods-producing sectors, and the rest relies on service-sector industries.
Unfortunately, data that breaks down the province’s GDP output by sector can be misleading because of how Statistics Canada constructs categories.
The government agency ranked real estate as the province’s biggest source of GDP, at 18.56 per cent in 2021, but that category includes all money paid in rent as part of the calculation.
Film production is in the information and cultural industries basket, which comprised 3.23 per cent of the province’s 2021 GDP, while arts, entertainment and recreation make up 0.6 per cent of B.C. GDP.
“It’s confusing because tourism is not an industry,” Business Council of British Columbia (BCBC) senior policy adviser Jock Finlayson said of the Statistics Canada GDP sector breakdowns.
“You have to construct estimates that are based on certain methodologies.”
Quirks aside, Statistics Canada’s GDP data supports the theory that B.C.’s reliance on energy and mining has weakened over the past decade.
Energy comprised 7.36 per cent of the province’s GDP in 2011, according to Statistics Canada. By 2021, that percentage had fallen to 5.38 per cent. Similarly, mining, quarrying and oil and gas extraction fell to 4.35 per cent of B.C. GDP in 2021, from 6.24 per cent 10 years earlier.
Sectors that include technology, retail and professional services are growing as a share of B.C.’s economy, according to Statistics Canada data. Still, these growth rates pale in comparison with anecdotal reports and industry data.
The Statistics Canada basket that includes film production fell slightly over the past decade, even though a record $4.8 billion was spent on film, TV, visual effects and animation in B.C. in 2021, according to Vancouver Economic Commission (VEC) research.
Thibodeau said his bank is seeing more demand for loans from B.C. entrepreneurs in those sectors.
“Our tech business is growing – tech and clean tech is growing exponentially,” he said. “Our film industry [lending] is very, very strong. We have a huge health-care practice at RBC, serving all healthcare professionals, like dentists and doctors, and any professionals. It is really growing, so there is demand there.”
Statistics Canada had retail accounting for 5.83 per cent of B.C.’s GDP in 2022, up from 5.71 per cent 10 years earlier.
Technology is harder to segment out, but the information and communication technology sector represented 4.63 per cent of the B.C. economy in 2021, up from 4.23 per cent in 2011.
The professional, scientific and technical services sector saw the biggest leap: To 7.3 per cent of B.C.’s economy in 2021, from 5.56 per cent a decade earlier.
Energy, mining and forestry are cyclical industries, and they are much larger in B.C. than the technology and other emerging sectors. As a result, resource-based sectors have much lower growth rates for business loans, Thibodeau explained.
Having a large resource sector has meant that energy, forestry and mining companies have through the decades headquartered their businesses in B.C.
Overall, however, the province has struggled to attract corporate head offices. It has fewer head offices per capita than other provinces, smaller head offices on average and a staff count at those offices that is on the decline, according to a recent Business Council of British Columbia (BCBC) report.
One trend has been for companies to grow and reach a certain size, only to get acquired by a company headquartered elsewhere.
Westcoast Energy Inc., for example, was B.C.’s largest public company when North Carolina’s Duke Energy Corp. (NYSE:DUK) bought it for approximately US$8.5 billion in 2002.
That followed Seattle-based Weyerhaeuser Co. (NYSE:WY) in 1999 snapping up B.C. forestry giant MacMillan Bloedel for about US$2.4 billion.
Goldcorp Inc. was similarly one of B.C.’s largest public companies when Colorado’s Newmont Mining Corp. (NYSE:NEM) bought the venture for about US$10 billion in an all-stock deal in 2019.
Teck Resources Ltd. (NYSE:TECK; TSX:TECK-B) is the latest example of a large B.C. resources company sought by an international player, with Switzerland-based Glencore PLC (LSE:GLEN) having submitted an unsolicited $22.5 billion bid to buy B.C.’s second-largest public company ranked by revenue.
Head offices are important for an economy because they provide well-paying jobs and business for local suppliers and professional-services firms. Large corporations often also provide a disproportionate amount of philanthropy and money to support local causes and events in cities where they are based.
Teck, for example, in 2010 donated $2.5 million to support the St. Paul’s Hospital emergency department. In 2021, it donated another $10 million to help the hospital build a new emergency department at its future False Creek Flats site.
Glencore has said that if it completes a deal to buy Teck, it might locate its new subsidiary’s Canadian head office in Toronto.
Unfortunately for B.C.’s economy, the province’s number of head offices fell to 310 from 319 between 2012 and 2021, according to the BCBC report.
“The economy grew, and the population grew substantially over that decade, and the number of firms also expanded, yet the number of mid-size and larger companies’ head offices didn’t grow in B.C.,” Finlayson said. “That speaks to a bit of a structural concern.”
Among the many reasons Finlayson listed for B.C. failing to attract head offices are that the province:
• is far removed from the country’s major population and financial centres;
• has heavy government involvement in various many sectors of the economy;
• has higher tax rates than other jurisdictions for skilled managers, professionals and scientists;
• has a small-business tax rate that increase sixfold to 12 per cent from two per cent once an income threshold has been reached; and
• has high land costs and scarce real estate.
Canada has an “inefficient and arcane corporate tax system,” and unwieldly regulatory regime for activities such as internal trade, he added.
B.C.’s head office losses extend beyond the resource sector.
RBC late last year entered into an agreement to buy Vancouver-based HSBC Bank Canada from parent HSBC Holdings PLC for $13.5 billion.
The transaction awaits regulatory approval, but RBC has said that it expects the deal to complete by the end of 2023.
Thibodeau said his bank’s plan is to keep most HSBC corporate head-office jobs in Vancouver.
“We will have a huge hub of jobs here on the West Coast,” he said.
“We are going to have not only the client-facing jobs, but a huge hub of jobs in technology, risk management and operations to support western provinces, and the West Coast – from Vancouver to San Diego, as we have a business in California.”
The idea of a rising China has become so entrenched in the Western imagination that it can seem inevitable. But economics rarely operates in straight lines, and in China, the government of Xi Jinping is right now making decisions about China’s economic relations with the world that are bound to alter its trajectory.
Xi, the most dominant political figure in China in half a century, would like his country to overtake the United States as the world’s premier superpower. In that pursuit, he is reorienting his country’s trade and investment away from the West and, in certain respects, looking inward to strengthen China’s economic defenses. China’s leaders argue that such decisions were forced upon them by a hostile Washington intent on maintaining its hegemony. In taking this course, they are also contributing to a larger shift in global affairs, as the post–Cold War moment of globalization has given way to a new era in which geopolitical competition and security concerns drive economic policy.
The story of China’s rise (so far) has been all about its relationship with the West, and especially the United States. More than 40 years ago, the paramount leader Deng Xiaoping introduced a free-market reform program that connected China’s destitute and largely agrarian populace to global supply chains through bonds of trade and investment with the U.S. and its partners. In flowed foreign capital and technology; out came manufactured goods for wealthy American and European consumers. Growth roared, and with it, incomes. None of that would have been possible without the West’s cooperation.
Beijing and Washington were once willing to set aside their numerous political disagreements in the pursuit of economic benefits that both believed were necessary for the future. But today, the two countries have come to see their ties as a source of risk and vulnerability. Xi fears that Washington can exploit its economic leverage to suppress his country’s rightful rise into a global superpower by withholding crucial technology or imposing punishing sanctions, such as those the U.S. slapped on Russia after its armies invaded Ukraine last year. He has sought to protect China by channeling enormous state support into developing homegrown technologies and by shifting China’s economic energies toward countries, including Russia, that are not perceived as threatening.
Washington, for its part, worries that China can use its dominance of certain supply chains, such as the production of rare earth minerals, to stymie U.S. industry, or that Beijing will capitalize on access to advanced American technology to enhance its own military capabilities or undercut U.S. economic competitiveness. Both the Trump and Biden administrations sought to curtail business with China through tariffs, export controls, and other measures, and encouraged investment in manufacturing at home.
Mike Gallagher, chair of the U.S. House Select Committee on the Chinese Communist Party, sees these shifts as commonsensical in many ways. “There are some people who want to go back to the halcyon days of economic engagement, in the hope that that might improve the U.S.-China relationship. I just think that represents the triumph of delusion over experience,” Gallagher told me. “We need to take off our golden blindfolds when it comes to the risks associated with doing business” with China, and “we need to reinforce our economic sovereignty in concert with our allies.”
And so the economic relationship between the U.S. and China—arguably the most influential of the past half century—is beginning to unravel. U.S. investment into China has been on the decline. In 2017, American companies invested $14.1 billion into China; in 2021, only $8.4 billion, according to the research firm Rhodium Group. In a recent survey of U.S. businesses conducted by the American Chamber of Commerce in China, 51 percent of the respondents said that their current plan was either not to increase their investment in the country or to decrease it, while another 26 percent said that the environment was too uncertain to decide.
Executives in Europe are hardly more enthusiastic. “While a handful of large firms, many of them German, continue to pour money into their China operations, many other firms with a presence in China are withholding new investment,” Rhodium Group explained in a 2022 report. “Virtually no new European firms have chosen to enter the Chinese market in recent years.”
Foreign investment suffered globally during the coronavirus pandemic, but China was hit harder than other countries and regions, according to a study that the International Monetary Fund released in April. The IMF noted that, during the pandemic period (roughly 2020 to 2022), compared with the preceding five years, the United States and the advanced European economies made significantly fewer “greenfield” investments into China—the term for when a company starts a new operation in a foreign country from scratch. Such investments into other regions, including emerging markets in Europe, held up much better. The study also revealed that foreign-investment flows are becoming more concentrated among countries that share similar geopolitical viewpoints. The IMF calls it the “fragmentation” of foreign-investment flows, but what it really means is that the decades-long love affair the West’s CEOs have had with China is coming to an end.
Chinese companies are withholding their money as well. The U.S. had been the most popular destination for China’s capital, with $193 billion invested since 2005, according to the American Enterprise Institute. Now Chinese investment in the U.S. has all but evaporated. Though it ticked upward in 2022 from the year before, to $3.2 billion, that’s a mere fraction of the nearly $54 billion invested in the U.S. in 2016.
Instead, Chinese firms are redirecting their investment to the global South. Last year, the two largest recipients of Chinese foreign investment were Saudi Arabia and Indonesia. Countries associated with Xi’s pet infrastructure-building program, the Belt and Road Initiative, accounted for less than a quarter of total outward Chinese investment in 2017, Derek Scissors, an AEI senior fellow, estimates. Last year, their share reached 60 percent (albeit of a smaller total amount). Though this shift reflects Xi’s foreign-policy preferences, it also shows how Chinese money is being scared off by a suspicious reception in the U.S. “Until that changes,” Scissors wrote in a January report, “investment will continue to shift to poorer countries.”
Although China’s trade with the United States and Europe remains immense, its exchange with the developing world is also growing. China’s largest trading partner is now not the U.S. or European Union, but the 10-country Association of Southeast Asian Nations—which includes Indonesia, Vietnam, and Thailand—with $975 billion worth of goods passing among them in 2022. China’s share of sub-Saharan Africa’s merchandise trade rose from a mere 4 percent in 2001 to more than 25 percent in 2020, surpassing that of both the U.S. and EU, according to a 2023 study from the Atlantic Council.
The shift in China’s global focus is likely to continue because it serves Beijing’s political interests. The new avenues of trade and finance Xi has opened through his Belt and Road program are designed to become routes of political influence. And a big reason Xi has been deepening relations with Russia is to secure sources of energy and other raw materials safely out of Washington’s reach. Trade between those two countries increased by more than a third last year, to a record $190 billion. Now Russians feeling the sting of U.S. sanctions are turning to the Chinese currency, the yuan, in preference to the dollar—furthering Xi’s goal of weakening the global influence of the greenback.
Washington’s position is hardening as well. Former President Donald Trump broke with decades of Washington policy by treating China as a potential adversary rather than partner. President Joe Biden has not only continued that approach, but sharpened it. His administration imposed tough controls on the export of advanced semiconductors and the equipment to manufacture them to China and is mulling new regulations that would curb U.S. investment in China in certain technologies.
Gallagher said that “restrictions on capital outflows to China make a lot of sense,” and that he thinks Washington may have to take a “sector-by-sector approach” to prevent American money from flowing into Chinese firms affiliated with the military or involved in developing sensitive technology, such as artificial intelligence.
The other advanced democracies appear headed in a similar direction. The hot term in Western capitals with regard to China policy is de-risking: not the extreme “decoupling” of the Trump era, which implied a harsh severing of ties, but a somewhat more moderate effort to counter Chinese threats to security and industry. De-risking could mean diversifying supply chains to make sure that Beijing’s position in them isn’t so strong as to afford it leverage over the West, for example. The language of de-risking was central to the communiqué that emerged from the May summit of the G7, as well as to a speech that Ursula von der Leyen, president of the European Commission, gave in March.
Detachment from the West would be a major shift in itself, but it is not the only one that China has undertaken. The country’s companies and banks are also, in many respects, scaling back their engagement with the world. A few years ago, Chinese firms were “going global” at a torrid pace. Now that outreach has become much more measured. AEI data show that total Chinese investment abroad has shrunk dramatically, from a high of $174 billion in 2017 to only $42 billion in 2022. The story of Chinese lending to developing countries is similar: From 2008 to 2021, the two Chinese state banks that support government-policy priorities issued $498 billion in development finance for 100 countries, according to Boston University’s Global Development Policy Center. That’s not far off the amount lent by the World Bank. But the loans began to taper off in 2018 and sunk to a mere $10.5 billion for 2020 and 2021 combined.
“We’re very much at a crossroads,” Rebecca Ray, a senior researcher at Boston University who tracks Chinese lending, told me. China’s retrenchment could reflect a decision to prioritize its domestic economy, which sagged amid the coronavirus pandemic and a property-market slump, she pointed out. But it is also possible that pragmatic concerns have led Beijing to pause its lending program before rebooting it to focus more on quality than quantity of development projects.
Whether these trends fully reflect a deliberate economic program remains unclear. The country’s strict COVID-prevention controls, which made cross-border business extremely difficult, may be skewing the numbers, and perhaps, with those restrictions lifted, China’s economic outreach to the world will rebound. Or Beijing may be at a transition point, with leaders looking to expand the country’s economic influence abroad, but with greater precision and effectiveness. But China is almost certainly amid a crucial strategic shift in its economic relations with the world.
The turn could ultimately be an inward one. Xi’s economic philosophy is based not on integrating with the world but on strengthening the homefront and marshaling Chinese resources for national endeavors and competition with the U.S. His mantra is “self-reliance,” by which he means eliminating his country’s vulnerabilities to the outside world, and especially the West. Doing so requires China to substitute imports with homemade alternatives. He may look for China to export its new high-tech products abroad but purchase as little as possible in return. Such a China will be one that doesn’t contribute as much as it could to the economic progress of its trading partners, and one that is less, not more, important to the global economy overall.
But an insular turn is not the only possibility. Xi is also detaching China from the West in favor of links to the global South. He’s taking a risk in doing so. The United States, Japan, and other advanced economies still account for nearly 60 percent of global output, while the developing world (excluding China) produces less than a quarter. That means that consumers in the global South, though they are becoming richer, cannot afford to buy as much from China as those in the West and other advanced economies. Nor can the global South offer the technology that the West can.
Thus, Xi’s fixation on security and power over economic efficiency is leading him to alienate the trading partners that can provide what the Chinese economy needs most for its growth, such as advanced technology, in exchange for ties to countries (like Russia) that cannot replace what is being lost. Whether China can continue its ascent under these conditions remains to be seen. But Xi’s choices are likely hindering, not helping, China in its effort to join the ranks of the world’s richest countries.
China’s current trajectory may make it a less formidable competitor to the U.S. economy. But American companies will likely lose out on profitable opportunities too. The costs of a separation between China and the West are potentially huge for the entire world, with all sides paying a price for determining economic policies based on who is friend and foe.
By Ted Carmichael
What triggered the sharp rise in Canadian inflation in spring 2021 is still a matter of debate. And it’s a debate that matters: the relative importance of the pandemic’s disruption of supply chains, Russia’s invasion of Ukraine, “greed,” or central banks’ financing of a surge in government spending will affect our response to future events. But once inflation gets started the initial causes are less important than the process that sustains it, which is a combination, on the one hand, of rising inflation expectations and costs and, on the other, of inadequate production.
When inflation has been low and stable — say two per cent — for some time then everyone knows that everyone knows that inflation will be about two per cent and behaves accordingly. It’s common knowledge. But when something disrupts that stable behaviour — a pandemic, a war, a big increase in government spending with deficits financed by central bank bond purchases — people’s behaviour changes.
First comes the response in markets with flexible prices: oil, copper, lumber, wheat and other commodities in high demand. As raw materials prices rise, processors and manufacturers who use them raise their prices to cover their increased costs. If the inflationary shock arrives at a time when aggregate demand exceeds aggregate supply, as it did in Canada in 2020-21, the initial shock is passed through to prices of other goods and services. (If there’s excess supply in the economy, the price increase is muted or takes the form of a slower reduction in prices than would otherwise have taken place.)
When there is this excess demand, workers who see their real income and standard of living being reduced by rising prices respond, not surprisingly, by demanding higher wages to catch up.
If the rise in prices persists, common knowledge and expectations begin to change. Every business knows that other businesses are raising prices to maintain their profitability. Every worker knows that other workers are asking for a faster pace of wage gains and are changing jobs, if need be, to get them. That is the situation we currently find ourselves in. Common knowledge has changed and inflation expectations appear to have increased to well above the stable two per cent target we grew accustomed to between 1995 and 2020.
Inflation gathers momentum when total compensation per worker outpaces the growth of output per worker, or productivity. A useful measure for capturing this relationship is growth in unit labour costs. When inflation picked up in the 1980s, compensation per hour outstripped productivity and unit labour costs grew by as much as six per cent per year. The 1990-91 recession pushed up unemployment and slowed wage growth, and productivity rose as the economy recovered, driving unit labour costs down. From 1992 through 2019, growth in unit labour costs averaged around 1.5 per cent per year, while inflation stayed close to the Bank of Canada’s two-per cent target — a stable process supported by expectations of two per cent inflation and modest, but positive, gains in productivity.
The recent inflationary shock pushed Canada back into a situation more like the 1980s. Compensation is rising, but productivity is not. Unit labour costs have grown an average of 4.8 per cent a year since the end of 2019. At the end of last year, the latest data show, compensation per hour was growing at a 5.2 per cent pace while productivity was falling at a 1.5 per cent pace, resulting in unit labour cost tearing along at 6.7 per cent. No wonder core CPI is up!
Breaking the momentum of Canada’s inflation will require some combination of slower compensation growth and faster productivity growth. Neither will be easy, and the inflationary late 1980s and recessionary early 1990s are both episodes we would like to avoid. Milder restraint of demand than took place in the late Mulroney years, combined with policies that boost investment and productivity, could hit the economic sweet spot of re-booting expectations without a recession.
The Bank of Canada has been restraining demand with higher interest rates. But recent federal and provincial budgets have done more to stoke demand with higher spending and borrowing than to boost productivity with investment-friendly tax and regulatory relief. For inflation to return to two per cent, fiscal and regulatory policies need to do more to ensure the faster productivity growth that will help break inflation’s momentum.
Ted Carmichael is a member of the C.D. Howe Institute Monetary Policy Council.
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