There has been a certain amount of discussion about the ‘decoupling’ hypothesis:
Economic train wreck in the U.S. would hit Canada, decoupled or not: After subprime, decoupling just might be the most overused word of the year in economics.A quick database search yields hundreds of newspaper stories about the decoupling phenomenon in the past three months alone.
Here’s the theory: Forget the notion that the global economy closely
tracks the fortunes of the mighty United States, that voracious
consumer of everything.The disciples of decoupling would have us believe that a new
paradigm has taken root as a housing slump hacks at the foundation of
the world’s largest economy. This is a made-in-America event, after
all, so why would Europe, Asia and emerging markets succumb to the
downward drag? Instead, they argue that booming Asia will lift Europe,
along with emerging markets from Africa to Eastern Europe…The decoupling theory has even gained a few fans in Canada, who apparently believe that Alberta’s oil will save us all.
BMO Nesbitt Burns economist Douglas Porter argued in a recent report
that it’s "a myth that every time the U.S. sneezes, Canada catches a
cold." He pointed out that four times since the sixties, Canada has
stayed in the black while the U.S. sank into recession – 1970, 1974,
1980 and 2001."Even if the U.S. economy does succumb to a full-fledged downturn,
that does not necessarily mean that Canada will also automatically
follow suit," Mr. Porter said.He pointed to looming tax cuts, the relatively healthy housing
sector, less restrictive credit conditions and still-strong commodity
prices as evidence Canada can hold back the tide.
This sounds a bit like what I said here a couple of months ago. It’s worth exploring a bit more in detail.
There are two aspects to this story. The first is the fact that the current expansion is not being driven by exports (see this post). Since Canada has been experiencing an improvement in its terms of trade, we are able to pay for strong import growth even though exports have been increasing fairly slowly:
This is of course good news: in an ideal world, we would be able to buy an infinite amount of imports in exchange for zero exports.
Would a US recession reduce our terms of trade? Probably, but much less than in the past. Oil and commodity prices are being driven largely by Chinese and Indian growth, and those forces don’t look to be slowing down anytime soon.
The other angle is that the share of exports that go to the US is declining:
Or we can look at the share of Canadian GDP that is exported to the US:
There are at least two explanations for the increase in exports to the US during the 1990s: FTA/NAFTA-induced trade shifts, and a booming US economy. But since then, non-energy exports to the US have gone from 30% of GDP to 20%, with no apparent ill effects. (I think it’s reasonable to expect that unless the US economy tanks completely, energy exports and prices are unlikely to be much affected.)
Now, 20% is still a very big chunk of our output, so we’re certainly not immune to whatever nastiness that is awaiting the US economy. But we’re probably in a much better condition to deal with it than we have been over the past few decades.
Update: Erik Poole – a graduate from the Laval MA program, currently working on his PhD at Simon Fraser University – has a well-thought-out counter-argument in the comments. Go read it.
Worthwhile Canadian Initiative 
I was also wondering if we were seeing a decoupling. Provided that that 2001 U.S. recession did not bring Canada into a recession while the previous ones have.
Keep us posted with your findings!
(Love reading your blog BTW)
Hi Stephen,
I agree that the Canadian economy is in excellent shape and much better placed to weather unexpected negative shocks than in previous decades. However, I’m not convinced of the de-coupling hypothesis.
The current Canadian expansion is driven by exports. The terms of trade would not have improved were it not for commodity exports. Other factors such as a recognition of the success of Canadian monetary policy or the receding threat of québécois independence might have contributed, but the big factor is clearly the robust demand and high prices for commodities in recent years. The resource-driven boom has spurred massive foreign investment flows.
The dynamism of convergence/catch-up Asian economies will likely blunt any deceleration of US economic growth. Combined with the increased importance of IT, freer trade, increasingly flexible global labour markets, etc., the recovery from any slowdown or recession in the US should be significantly faster than in previous periods.
However, even if the US only slows down, e.g., <2% real GDP growth, or ~0% per capita GDP growth, without going into recession, I find it hard to imagine that growth in Asian and other emerging economies would not be negatively impacted.
The result will inevitably be lower base metal and energy commodity prices which will feed back into reduced Canadian output growth and reduced terms of trade. A similar picture emerges if we look at individual commodity markets. The natural gas sector in western Canada has been hammered by the rising Canadian dollar as well as increased liquid natural gas (LNG) imports into North America. Those LNG imports are slated to increase more. Granted, winter weather could ultimately play the decisive role in determining natural gas prices.
The US is still a relatively important user of base metals. Marked slowdowns in consumer durable sectors risk continuing to put downward pressure on those base metal prices that have already corrected more than 1/3 from recent peak prices.
Political rent-seeking, chronic mismanagement as well as mounting international competition have literally crucified the forest products industry.
Based on traditional economic fundamentals, oil appears over priced. Wouldn’t surprise me at all to see oil back off to the US$60 to $US75 range. I suspect that Bush II Middle East policies, particularly the sabre-rattling against Iran, are keeping the political risk premium high. Barring some mysterious exchange rate inertia, a ~1/3 decrease in the price of oil as measured in US dollars should directly lead to a deterioration in the terms of trade.
You may recall that in the late 1990s when several Asian Tigers went into deep recession, both China and the USA kept growing yet commodity prices hit historic lows.
None of the above contradicts this notion of a commodity supercycle that many predict. It is just that the ‘re-co-ordination pause that refreshes’ in the US will likely feel painful up close. As recent history suggests, the US could go into recession and Canada could technically avoid one. But if growth slows to zero or negative rates on a per capita basis, there will be plenty of pain and bellyaching.
Perhaps I am missing something. The recession of the early 90’s was one in which the U.S. and Canada suffered together – i.e. were not decoupled. From the chart, this was a period where we exported ~15% of GDP to the U.S. The 2001 recession in the U.S. was one which did not affect Canada as much – i.e. the two economies were (somewhat) decoupled. From the chart, this was a period where we exported ~30% of GDP to the U.S. So, from this data, we conclude that now that our percent of GDP exported to the U.S. has dropped to ~20%, we are decoupled more than in the past few decades? I don’t really see how the charts line up with the argument. I can follow that if are exporting more oil and gas and oil and gas prices are determined internationally vs. based on what happens in the U.S. then we are less dependent on the U.S., especially given inelastic demand for oil and gas, but the rest?
Actually, exports increased during 1990-1991 – see the post I referred to above. A lot of what was going then was homegrown – especially the Bank of Canada’s Great Disinflation.
I don’t want to overstate the point. No-one – and certainly not Canada – will be immune to what happens in the US.
how is the decoupling theory working out for you and mr porter? I thought the emerging markets were going to buy all our commodities and who would have thought this would happen? hahahaha