If you squint and hold your head at just the right angle, it is possible to persuade yourself that the US economy has reached at least a point of inflection: the most recent news about housing, auto sales and initial unemployment claims are less bad than what we've become used to seeing. But even if the US economy stops contracting in the next six months or so, that still doesn't mean that it will be bouncing back anytime soon: the US economy may well have a Japanese-style non-recovery ahead of it for some years to come.
I've been trying to work out what all this means for the prospects of a Canadian recovery. Clearly, a strong US bounce-back from a trough would be a sufficient condition for a Canadian recovery. But that doesn't mean it's a necessary condition. (For those of you who are unfamiliar with the distinction, here's the wikipedia entry.)
My less-than-definitive thoughts continue below the fold.
For all that you might have heard about the importance of exports to the Canadian economy, net exports have been a drag on growth over the past expansion:
Compare this graph to Paul Krugman's summary of the sources of Japan's growth during 2003-2007. Canada's fortunes have been tied more to the prices of what we export than to to the quantities. As noted in exhaustive detail over here, as long as Canada's terms of trade held up, we were able to fend off the US recession.
To the extent that our terms of trade are determined by commodity prices, then a strong US recovery would be a sufficient condition for a return to the halcyon days of the mid-00's. (Will someone please come up with a convenient term for this decade? Thank you.) A strong US recovery would mean that they'd managed to fix everything that is wrong down there, and that the US economy would stop being a drag on the rest of the world.
But is a US recovery a necessary condition for higher commodity prices? Here, one's eyes turn to China. As Jim Hamilton documents, much of the 2007-8 surge in oil prices can be ascribed to an increase in Chinese consumption. And no doubt a similar story can be applied to the prices of other commodities.
It could be argued that much of this increase was derived from US demand for Chinese exports, so the US was still the driving force in commodity prices. But to the extent that the Chinese stimulus package succeeds in redirecting aggregate demand from net exports to domestic investment – and there seems to be some reason to be optimistic on this point – then commodity prices may resume their upward trend. This story would be consistent with a Canadian recovery, but a US recovery would be slowed by higher oil prices.
Although it's possible to imagine scenarios in which Canada recovers while the US does not, I can't think of one in which Canada recovers while China remains stuck in recession. Maybe we should be paying more attention to what's happening in China than to what's happening in the US
Worthwhile Canadian Initiative 
It’s interesting to see more people playing with what-ifs that don’t involve a US recovery. The Americans have very serious structural problems to deal with, seem determined to repeat every mistake the Japanese made and have a major problem with corruption/elite self dealing that will need to be dealt with before they’ll be able to make meaningful progress on bank insolvency. Fixing everything could take decades and nobody–not us, not the Chinese, not the Europeans–should count on the US leading the way towards recovery anytime soon.
Under the current conditions, I cannot imagine a particular scenario in which Canada recovers while the US does not-… and neither does Europe and other countries like India…. I do not see how can China have a relevant recovery under those circunstances …. in any case, unfortunately for Mexico, the US recovery is a necessary condition…
Alejandro
For the non-experts in the room. How can exports be producing negative growth? Don’t exporters start exporting when that’s the case?
I see this as an extremely remote possibility, but if the world were to go into an extreme depression I think Canada could recover on its own with a series of very radical measures.
If there is a serious and long lasting depression throughout the rest of the world, and maybe even a trade-disrupting military conflict, I think Canada could always revert to some sort of autarky. Obviously this would be a last resort, and likely to be a far worse outcome than any shared recovery, but I do see it as an important put on Canada’s economic situation during a prolonged global crisis.
We have all of the natural resources necessary to run a functioning economy, functional banks, well-educated populace and well-developed industry. The problem is that Canada is small, and gets tossed around on the global markets, so we just end up riding commodity booms and US consumer demand. Now suppose that Canada’s exposure to world markets becomes a net negative: constantly falling import prices and shrinking export markets are hammering our industries, commodity prices are low for the foreseeable future. At a certain point, it might be preferable to slap huge tariffs on imports and shift towards a closed economy. To be clear, this would be an extreme “survivalist” type measure, but would enable Canada to disengage from a global deflationary spiral. Fiscal and monetary stimulus would be very simple to carry out in a closed economy.
In general though I agree with Stephen’s idea: recovery is most likely to come in the form of commodity demand (and hopefully demand for consumer goods) from China if they are successful in raising domestic demand, rather than consumer demand in America for cars etc. which seems far less likely to bounce back. Also, I don’t see how the American economy can recover in the long term without balanced trade vis-a-vis China, so I see the rebalancing of the Chinese economy as the primary factor in establishing a sustainable recovery. Hopefully this would lead to increasing demand for Canadian goods besides commodities, and minimizes the effects of the commodity curse, but either way, we seem well-positioned for recovery.
Since others have commented on content: my preferred name for the ’00 decade is The Noughties.
I think that recovery of US financial markets is a necessary condition for a Canadian economic recovery. Normalization of credit markets + increase in terms of trade sounds like a good recipe for a decent uptick in growth in 2010.
Greg – I’ll second you on The Noughties.
That sounds right. It’s hard to see how trade flows are going to recover if credit markets remain frozen.
I think I prefer Aughties to Noughties, since it isn’t a homonym.
Very interesting article. As a Japanese, now I can understand what happened in Japan more clearly than before, as it is almost asymmetrical to what happened in Canada.
However, when I checked data, recent net export(NX) contribution to Canadian GDP growth on nominal basis was also negative — -3.4% of 2002-2008 growth 44.6%. As real GDI can be roughly approximated by (real GDP) – (real NX) + (nominal NX), this means trade was dragging factor not only for real GDP, but also for real GDI. That is, although trade factor did improve GDI compared to GDP, it abated pure-domestic economy growth after all. Canadians seems to have bought pizzas a bit too much.
Sidenote: As for Japan, NX contribution to nominal GDP growth during 2003-2007 is mere 0.1%. I pointed out this fact to Krugman in his blog comment repeatedly, but apparently it didn’t get through.
I should have written symmetrical, not asymmetrical.
To JC: Net export is export minus import. As you noted, export itself cannot be negative. But if you import more than you export, net export becomes negative.
Thanks himaginary (and since your helpfulness is contagious, Krugman is too large a figure to run a blog, which needs tending and immediacy –features that are in abundant supply here at WCI, where you can read the interaction of the comments…not like the isolated offerings at K’s waiting to be reviewed for publication…it is a dead catalog)
Is there a reason why we have to stare down this particular interval (2002-2008)? My unorthodox approach is to view the GDP runnups in most countries as the bloatation of the housing markets germinated in the US, so “eatin pizza” (as cute as Noughties…don’t ignore the multiple entendre missing in Aughties) strikes the wrong chord for me…but I can be revised…not like some other blogs.
It is early for the Canadian economy and what seems to me a significant penetration of a now faltering US economy at the center of a global downturn.
I wonder to what extent the relative health of our financial system compared to the disaster that is much of the rest of the world will help us? Does it make us less likely to fall into a ‘deep’ liquidity trap? Based on the astounding level of excess reserves at the Fed and it’s close correlation with the increase in the monetary base, the US liquidity trap seems to be caused by insolvent banks hoarding cash against expected loses rather than individuals and firms hoarding cash out of conviction that there are no profitable endeavors in which to invest. Which makes me wonder: are zombie financial intermediaries eating Uncle Ben’s brains? And if that is the case, the sooner Timmy grows a pair and channels Ash, the sooner monetary policy can start working again.
Ash for Treasury Secretary; he’s one crazy zombie killing mofo.