“Our businesses will need to develop new markets as the traditional advantage of relatively open access to U.S. markets becomes less valuable.”
-Mark Carney, governor of the Bank of Canada, Sept. 28, 2009
Executive Summary
Close geographic proximity and a common culture have encouraged extensive trade and investment ties between Canada and the United States in the post-World War II era. About 10 years ago, the United States was the destination for nearly 90 percent of Canada’s exports and Americans accounted for two-thirds of the foreign direct investment holdings within Canada. Over the past decade, however, Canada has developed deeper trade ties with the European Union and the share of foreign direct investment accounted for by Europeans has grown to 30 percent. Due to strong economic growth in the developing world, Canada’s exports to those economies have nearly trebled since 2000.
The Canadian economy was pulled into recession at the end of last year due largely to the deep downturn in the United States. However, there are signs that Canada is emerging from its recent slump, and we look for the Canadian economy to modestly outperform its southern neighbor over the next few years. Will Canada ever “de-couple” from the United States? Probably not. Geographical proximity, cultural bonds and a common language ensure that the two economies will remain highly integrated, and economic and financial shocks in the United States will continue to be felt north of the border. However, the high-water mark of Canadian-American economic integration has probably been reached already. Economies other than the United States will become increasingly important, at least at the margin, for Canada in the years ahead.
When the United States Sneezes…
The economic fate of Canada has long been tied to the health of the U.S. economy. Indeed, there is an old adage that says, “When the United States sneezes, Canada catches a cold.” There is little doubt that Canada was pulled into its current recession by the United States. In fact, it seems that in the current cycle the second half of that old saying could be amended to “the whole world catches a cold.” This cycle is different to some extent in that the chain of events set off in credit markets by the Lehman Brothers bankruptcy demonstrated the inter-connectedness of the global financial system, rather than a dependence on the U.S. economy per se. Lehman’s failure was the catalyst that set off a chain reaction, which sent the global financial system into a tailspin and threw most of the world’s developed economies into their worst recessions in the post-World War II era.
As the global recovery begins to take shape will Canada’s fortunes continue to be tied almost exclusively to the U.S. economy? Or will steady domestic demand and a decade of expanding global ties help Canada look to markets other than the United States to sustain its own economic growth?
We begin with an evaluation of past economic cycles to get a better sense of the relative performance of these two economies. The data show there is a substantial connection between the two economies, but different cycles have led to different outcomes. Part of the explanation for that variability comes from the fact that other facets of the economy, such as domestic spending, have reacted differently depending on the cycle. Then we examine the specific economic dynamics such as trade and foreign investment which contribute to the shared fate of these neighboring countries. Finally, we take stock of various changes in the way Canada does business with foreign economies other than the United States over the course of the past decade, which may make the country’s economic and financial situation somewhat less dependent on the U.S. economy in the years ahead.
