The Weekly Wrap, February 2, 2024
Inflation wait and see and the productivity imperative
By Mark Parsons, ATB Economics 2 February 2024 11 min read
In this week’s ATB Economics Weekly Wrap…
- A better finish - Canadian GDP surprises
- Lighter finger on the pause button - U.S. Fed signals future rate cuts
- Landing soft - IMF’s latest global outlook
- A tighter Alberta rental market - Record migration fuels rate increases
- Interesting Fact: Fertility rate hits new low
- Topic/Chart of the Week: Productivity trends - Part 1
This week we had a stronger finish to 2023 growth in Canada, and the Fed Reserve on the sidelines for the fourth straight meeting in the U.S. In both countries, it seems like we’re waiting for the same thing—softer inflation data before the first rate cuts. We tackle productivity this week in part 1 of our series.
Canadian economy shows signs of life
The economy surprised to the upside in November/December, but is still struggling to grow even as population surges. For the Bank of Canada, this should have little impact—if anything it strengthens their data dependent approach. Growth is expected to be soft in the first half of 2024, and the first rate cut won’t come until there’s a meaningful turn in inflation.
Yet again, it looks like Canada will avoid a ‘technical’ recession of two straight quarterly declines in GDP. With the latest monthly GDP data, the economy is poised to grow 1%+ (annualized) in the final quarter—exceeding the Bank of Canada’s expectations of zero growth.
But growth numbers aren’t as rosy when accounting for the 3%+ annual population gain. In per capita terms, Canada’s economy has been contracting since mid-2022. Canada’s growth also pales in comparison to our southern neighbour, where GDP surged in the second half of the year (see chart).
We don’t have a provincial breakdown, but there are some clues as to what’s happening in Alberta. National oil and gas extraction GDP jumped 1.5% in November on surging oil sands production. The industry is preparing for the long-awaited Trans Mountain Expansion pipeline to come online. The project has run into more technical snags, but is still expected to come into service in the second quarter this year.
U.S. Federal Reserve - just a little longer
‘Rate cuts are coming, but you need to wait’ was the central message from the Federal Reserve on Wednesday. Tom Petty’s The Waiting is on point yet again. So we wait for more signs that inflation is on its path to 2%.
The Fed stayed on the sidelines, keeping the target for the federal funds rate at 5.25-5.50%. It also pulled a move similar to the one the Bank of Canada made last week, removing from its policy statement that it's considering rate increases.
Rate cuts seem to be around the corner. But like the Bank of Canada, the Fed doesn’t seem to be in a rush. Chairman Powell all but dashed hopes for a March cut when he said “I don’t think it’s likely that the committee will reach a level of confidence by the time of the March meeting.” Powell noted the progress—the Fed’s preferred measure of inflation is now below 3% despite a roaring economy (jobs data released today show a stunning 353K payroll increase in January)—but says “we just need to see more.” Sound familiar?
For more, check out this commentary from the rate’s desk at ATB Capital Markets.
Interesting Fact: Canada’s total fertility rate fell to its lowest level on record in 2022, hitting 1.33 children per woman according to a new study from Statistics Canada. Fertility rates have been trending lower for years, peaking in 1959 at 3.94. While the ultimate impact of the pandemic is unclear, the study suggests that the pandemic may have disrupted fertility patterns by increasing uncertainty. In Alberta, fertility declined to 1.45 in 2022, but remained above the national average and third highest among provinces (after Saskatchewan and Quebec).
The International Monetary Fund’s latest forecast report, released Tuesday, is slightly more cheery than in October, but still cautious. Here are the highlights:
Better than before: It’s hard to believe with all the negative news floating around, but the world economy has exceeded expectations. Back in the days of sky-high inflation and following the invasion of Ukraine by Russia, there was plenty of talk about a hard landing. The IMF’s forecast from October 2022 pencilled in U.S. real GDP growth of 1% versus the advance actual of 2.5% in 2023! The IMF has consistently upgraded its view on 2023 (see chart). The latest upgrade to global growth in 2024 reflects a resilient U.S. economy and recent fiscal support in China.
A soft landing is still soft: This is a soft landing forecast—that is inflation will come down without crushing the global economy and spiking unemployment. But 3.1% is still not great—well below the 20-year average of 3.8%.
A little less inflation: Most reassuring is progress in the inflation fight. The IMF shaved its outlook for global inflation in 2024 amid tighter monetary policy and easing supply chains.
More bullish on Canada: We don’t know why (they don’t tell us), but the IMF’s Canadian forecast for 2024 (+1.4% real GDP) is much higher than many others, including ours (we’re tracking 0.7%) and the Bank of Canada’s (0.8%). Our hypothesis is that they’re assuming a much more resilient consumer as mortgages and other loans reset, but that’s a guess.
Not out of the woods: We can’t breathe easy just yet. There are a few risks that could reroute the global economy to a harder landing. Here are a few things the IMF is worried about: Red Sea attacks, which could clog supply chains and spike commodity prices, tighter fiscal policy, a Chinese slowdown, and sticky inflation.
Alberta’s rental market tightens, as supply struggles to keep up with booming population
Rapid population growth and a healthy labour market has contributed to a much tighter rental market in Alberta’s two largest cities, according to a new report from the Canada Housing and Mortgage Corporation. Higher interest rates have also played a role, constraining home building and pushing some into the rental market.
In Calgary, the average rent for a two-bedroom unit (purpose built rental) jumped 14.3% to $1,695 last year, the strongest increase since 2007. The vacancy rate for purpose built rentals dropped from 2.7% to 1.4% (lowest in a decade). The report notes, however, that new inventory is coming on-line with purpose built apartment rental starts hitting record highs last year, and office-to-condo conversions underway.
In Edmonton, two-bedroom rent rose 6.4% to $1,398 while the vacancy rate dipped from 4.3% to 2.4%. Edmonton’s smaller increase in 2023 can be attributed to a larger rental stock that could better absorb demand. The supply picture is mixed: while the rental universe expanded in 2023, new apartment starts declined last year.
Among major CMAs, the most expensive markets remained Vancouver ($2,181, two-bedroom purpose built rental) and Toronto ($1,961) in 2023, while Montreal CMA came in the lowest at $1,096.
Topic of the Week: Productivity - Part 1
“Productivity isn’t everything, but in the long run it’s almost everything.”
—Paul Krugman, Nobel Prize winning economist
Over the next two weeks, we are talking about productivity. We start with why it matters and a high level summary of recent trends in Canada and Alberta. Next week we dive into more industry level details.
Why productivity matters
Economists spend a lot of time talking about productivity, and for good reason. Productivity drives living standards and real wages over long periods of time. This is not just an academic exercise: to sustain real per capita income growth, labour productivity must increase over time.
In general, there are two main ways of increasing GDP per person (a broad measure of living standards).
- More hours worked per person: This can be through increased labour force participation (particularly among underrepresented groups), increasing the share of people in their prime working years (e.g. through immigration), or increased weekly hours (e.g. more full-time work).
- More output per hour worked (i.e. labour productivity): This can occur through more capital per worker (capital deepening), improved labour ‘quality’ (e.g. skills and training), and something called multifactor productivity which involves using all inputs more efficiently.
Productivity doesn’t mean working hard, but smarter. It can involve upgrading skills, investing in machinery and technology, commercializing and developing new products, and expanding into new markets.
An aging population is one reason to care more about productivity. As the population ages, more people will exit the workforce, leaving fewer workers available to support themselves and their retired peers. Productivity will need to carry the economic weight. Alberta’s population is young, but it’s still aging. The population 65+ is expected to rise from 15% today to 20% in 2051, which will lower overall labour force participation rates.
Inflation is another reason to take productivity seriously. Wage gains, in the absence of productivity improvements, lead to higher unit labour costs. While companies may absorb the hit to their bottom line, over long periods they are likely to pass these costs on to consumers in the form of higher prices. Bank of Canada Governor Tiff Macklem noted in September that “weak productivity growth has been a serial problem in Canada,” and in its latest Monetary Policy Report the Bank highlighted that the combination of strong wages and weak productivity could add to inflation.
Labour productivity in Canada has been on a steady decline since the pandemic.* As of the third quarter of 2023, labour productivity was below 2019Q4 levels and approaching late 2014 levels. Not surprisingly, then, GDP per capita has been declining since mid-2022.
While Canada’s languishing productivity is more noticeable at the moment, it predates the pandemic (see chart). A ‘silver bullet’ solution to these challenges would be nice, but there is no one single reason why Canada lags. Lower levels of business investment (particularly in machinery and equipment and intellectual property) are considered a key culprit. Indeed, real business investment in structures, machinery and equipment and intellectual property remains below 2014 levels. Other potential explanations cited include weaker innovation outcomes on measures like business R&D, patent ownership and commercialization, lack of competition, firm size, internal trade barriers, skills gaps, and taxes.
*Labour productivity temporarily spiked during the first year of the pandemic as activity shifted to essential activities and industries reduced labour more than output. The reopening of the economy reversed these effects as hours worked rose faster than output.
What about Alberta? The province has the highest level of overall labour productivity, standing neck and neck with Saskatchewan, another major natural resource producer. In 2022 (latest data), output per hour worked was 32% higher than the national average economy-wide, and 39% higher in the business sector.* The capital and energy intensive structure of Alberta’s economy is the main reason for its higher productivity level. More on this next week.
Reflecting higher productivity and employment rates, Alberta has the highest GDP per capita among provinces. Trevor Tombe, a Professor of Economics at the University of Calgary, finds that Alberta is the only province that exceeds the national average on per capita GDP when adjusting for differences in purchasing power.
*Rankings are similar in the business sector only, though Saskatchewan moves to first with Newfoundland and Alberta effectively tied for second in 2022.
Turning to growth, labour productivity has risen 0.9% per year over the latest decade of data (2012 to 2022), matching the national average. However, this was entirely due to gains in the early part of that period, with productivity struggling to gain ground since the 2015-16 recession. The peak in Alberta’s productivity gap, relative to the national average, was in 2014. Looking at a 20 year horizon, Alberta’s productivity growth comes in at 0.8% per year vs. 0.9% nationally.
Labour productivity in Alberta is highly influenced by its largest industry—oil and gas extraction, which has very high levels of labour productivity. There has been a decline in hours worked in oil and gas and related industries since 2014. At the same time, hours worked has increased in many other industries, particularly in the service sector, with lower average levels of labour productivity. This structural shift has weighed on the average level of productivity in Alberta.
At the same time, and providing a partial offset, there have been large improvements in the oil and gas industry’s labour productivity over the last decade, with a big jump between 2012 and 2016 before leveling off. The gains can be attributed to oil sands projects moving from the construction phase to production phase and continued efforts to find efficiencies and contain costs.*
Next week, we’ll dig into detailed industry-level data to explore recent trends and find out why Alberta’s overall labour productivity is higher.
*The long lead times between initial investment and production and volatility in the resource sector are a reminder that year-to-year productivity changes are difficult to interpret in Alberta, and will not necessarily be indicative of trends.
Answer to the previous trivia question: Economists refer to the additional benefit from an increase in an activity as marginal benefit.
Today’s trivia question: In economics, the revenue earned from “labour” is called “wages.” What is the revenue earned from “land” called?