Report A: ECONOMIC REVIEW AND OUTLOOK

Introduction

As 1997 began, there was a greater-than-usual amount of uncertainty about British Columbia's economic outlook. Last year appeared to end strongly relative to the preceding quarters yet uncertainty remained about key sectors of the economy. As a result, it was unclear whether the economy was poised to return to the strong growth of the 1993-94 period or would remain relatively sluggish.

With these issues in mind, the Minister of Finance and Corporate Relations held an economic outlook conference in Vancouver on February 20, 1997. The conference brought together forecasters and other economic experts to discuss the likely paths of growth in 1997 and 1998. Holding the conference just over one month prior to the budget provided very up-to-date opinions on the outlook.

A summary of the views expressed and forecasts provided by participants in the conference appears on pages 10 through 12. These views have assisted in developing the economic outlook for 1997 and 1998 that follows, as well as the revenue projections underlying the budget.

As a result of this process, the public can:
-- see that there is a wide range of views on the economic outlook; and
-- evaluate the government's economic forecast in relation to other opinions.

The economic outlook and revenue projections in the budget remain the responsibility of the Minister of Finance and Ministry of Finance and Corporate Relations staff.

 
1996 In Review

Last year was a difficult one for the British Columbia economy. The slowdown that began during the second half of 1995 continued through most of 1996. Growth accelerated late in 1996, allowing the economy to post growth of around 0.5 per cent for the full year ¹. [Table A1]

 
A bright spot in 1996's performance was continued strong growth in employment. In fact, British Columbia's performance in this area ran counter to a number of other economic trends as employment rose 2.5 per cent, representing an additional 44,000 jobs. The increase in total hours worked was less robust. The unemployment rate held steady at 8.9 per cent as an equivalent number of job seekers entered the labour force. Labour income grew 3.7 per cent, reflecting the growth in employment and modest gains in average earnings during the recent period of low inflation.

The housing market also rebounded in 1996, with starts rising 2.2 per cent and existing home sales rising 24 per cent. Other positive developments in 1996 included the strong growth in transportation and tourism activity caused by the expansion of the Vancouver International Airport, and the continued growth in areas such as the high-technology, telecommunications and entertainment industries.

The slowdown in the economy in 1996 was largely attributable to a drop in export earnings and capital investment (see Table A1, "Contributions to 1996 Real GDP Growth").

• The value of British Columbia's foreign merchandise exports fell 6.5 per cent, reflecting sharp declines in the prices of key forest and mining exports such as pulp, paper and copper (see Chart A1). Total goods and services export volumes to other parts of Canada and the rest of the world were down an estimated 0.2 per cent.

• Total capital investment fell an estimated 0.6 per cent in real terms, largely due to a 9.6 per cent decline in non-residential construction. This offset impressive gains in machinery and equipment investment and a recovery in residential construction during the second half of 1996.

Consumer spending grew an estimated 2.4 per cent in real terms. Services spending held up, perhaps due to tourism spending, but British Columbians were reluctant to spend on autos or other durable or discretionary goods. Retail sales grew only 0.5 per cent in real terms. Expenditure by federal, provincial and local governments is estimated to have contributed slightly to economic growth in real terms.

The drop in export earnings severely undercut corporate profits, which declined an estimated 30 per cent on a pre-tax basis. Lower average interest rates in 1996 caused a drop in aggregate investment income. The decline in profits and investment income resulted in very slow growth in aggregate provincial income (or nominal gross domestic product -- GDP).

The British Columbia consumer price index (CPI) rose 0.9 per cent in 1996, the lowest rate among the provinces. This largely reflected a decline in housing costs and the provincial government's freeze on auto insurance premiums. Broader economy-wide measures of inflation, such as the GDP price deflator, are estimated to have risen even less than the CPI because of falling prices for exports and capital goods.

 
1997 British Columbia Outlook: Overview

The economy is expected to grow 2.2 per cent in 1997, well above 1996's pace. Stronger growth in the rest of Canada and slightly better conditions in key export industries should ensure that economic conditions improve over the course of the year. Housing markets are expected to strengthen. Non-residential construction should begin increasing significantly during the second half of 1997. Table A2 provides forecast details.

Major Markets: The United States, Japan and the rest of Canada absorbed 80 per cent of British Columbia's merchandise exports in 1996. On balance, the external outlook in 1997 is similar to 1996's performance, with stronger growth in the Canadian economy being offset by weak performance by Japan. The Canadian economy is expected to do considerably better than 1996's disappointing 1.5 per cent growth rate. Japan's economy grew 3.6 per cent in 1996, but it is likely to grow just 1.5 per cent in 1997. Meanwhile, the U.S. economy has continued to strengthen and is expected to grow 2.3 per cent this year. Table A2 outlines the assumptions used for growth in British Columbia's major markets.

Export Prices: Led by declines in pulp, paper and copper, the Ministry of Finance and Corporate Relations export commodity price index fell 6.3 per cent in 1996. Overall export prices, including services as well as goods, fell an estimated 0.9 per cent. With prices for copper, pulp and newsprint likely having bottomed recently, export prices are expected to rise 1.0 per cent in 1997.

Financial Markets: Monetary conditions in Canada eased considerably over the course of 1996. Short-term interest rates fell almost 2 percentage points and Canada-U.S. short- and long-term interest rate differentials narrowed sharply (see Chart A2). The average value of the Canadian dollar in 1996 was about 2 per cent higher against the currencies of the country's major trading partners.

Some increase in U.S. interest rates is expected in 1997, particularly since recent data suggest the economy will grow faster in the first half than was generally expected. As a result, the U.S. economy may be bumping against capacity before long. The forecast assumes that Canadian short-term interest rates will rise in line with U.S. rates, but that long-term rates will be relatively stable. Given that Canada's economy continues to operate well below potential, the likelihood of sustained interest rate increases is much less than in the U.S.

It was widely anticipated at the beginning of the year that the Canadian dollar would appreciate against the U.S. dollar in 1997, but a significant appreciation now appears unlikely. The dollar is expected to average 74.3 U.S. cents in 1997, up from 73.4 cents in 1996.

 
Labour Markets and Income Growth

A strong fourth quarter in 1996 provided a solid foundation for job and economic growth in British Columbia in 1997. Although this year got off to a slow start with a decline in employment from the fourth quarter, the Ministry of Finance and Corporate Relations still expects reasonable growth through 1997.

Employment is expected to grow 2.2 per cent in 1997, adding about 40,000 jobs in the province. The labour force will grow at a slightly slower pace, reducing the unemployment rate to 8.6 per cent. Net in-migration is expected to total 57,400 people this year, down from 60,600 last year. As in 1996, a greater proportion of in-migrants will continue to come from overseas rather than other parts of Canada.

Growth in hourly earnings of 1.5 per cent should result in an increase in labour income of 3.5 per cent. However, slow growth in interest, dividend and miscellaneous investment income will keep overall personal income growth close to 3 per cent (see Chart A4).

 
The Consumer Sector

Conditions in the job market and the consumer sector strengthened in the fourth quarter of 1996, providing a solid foundation for growth in the coming year. [Chart A3]

While traditional drivers of consumer spending, including interest rates and employment growth, are expected to remain favourable in 1997, there are other factors that may come into play in determining the consumer sector's contribution to overall growth. These factors include concerns about job security, changing demographics and a shift in focus towards increased saving for retirement rather than consumption spending. Given this environment, real consumer spending is expected to increase 2.2 per cent this year.

In-migration during the past few years has contributed to considerable pent-up demand for housing in the province. Lower financing costs combined with last year's decline in house prices will likely stimulate housing demand and construction. Housing starts are expected to total 30,200 units in 1997, a 9.3 per cent increase from 1996.

Consumer price inflation is expected to average 1.6 per cent in 1997, up from 0.9 per cent in 1996.

 
The Business Sector

Corporate profits are the most volatile of the major components of aggregate income and their 1997 outlook depends heavily on the path of natural resource prices. Last year, a 50 per cent decline in pulp prices followed to a lesser extent by a decline in newsprint prices eliminated profits of major integrated forest companies. The only bright spot in the forestry sector was lumber prices. In 1997, most of the province's key commodity prices are expected to improve. This increase in prices combined with higher volumes will likely lead to an improved corporate profits outlook.

In 1997, pre-tax corporate profits are expected to grow 15 per cent, following the sharp downturn last year. Even with this year's forecast increase, corporate profits will recover only half of the ground lost in 1996.

Non-residential investment, comprising non-residential construction (for example, office and retail buildings) and machinery and equipment investment, is expected to grow 2.7 per cent in real terms in 1997.

Non-residential construction activity is expected to pick up in the second half of 1997, spurred by relatively low office vacancy rates in Vancouver. There are also a number of large hotel projects planned this year in the Lower Mainland. Public sector construction is forecast to decline in real terms as federal, provincial and local governments continue to exercise fiscal restraint. Machinery and equipment investment will grow moderately in real terms, stimulated by declining prices and continued low interest rates.

Total capital investment -- construction and machinery and equipment -- is forecast to increase 3.2 per cent in 1997 in real terms. This is in line with the 5.1 per cent current-dollar increase in planned investment reported in the Statistics Canada private and public investment intentions survey in February 1997 (see Chart A5).

Inventories are a volatile component of aggregate demand that can vary significantly from year to year. A buildup of unwanted inventories in one year can mean lower production in the following year because any increased demand will be met from stocks rather than through higher output. In British Columbia, the pulp and paper industry appears to play a major role in such inventory swings.

No provincial data on inventory movements in 1996 are yet available. However, company financial reports and other evidence such as numerous temporary mill closures suggest that pulp and paper inventories rose in 1996, despite price cuts designed to reduce unwanted stocks. As a result, pulp and paper inventories are expected to decline in 1997. This will reduce overall growth slightly as demand will be met through inventory draw-downs rather than increased production.

 
The Government Sector

Spending at all levels of government remains constrained by deficit and debt targets. Growth in total spending by all levels of government is expected to be under 1 per cent in real terms in 1997. Report C discusses the capital expenditure plans of the provincial government.

 
1998 Forecast

The British Columbia economy is expected to grow 2.5 per cent in 1998. With employment growth of 2.2 per cent, the unemployment rate will continue to fall. Inflation is expected to be 1.7 per cent. Capital investment is forecast to grow strongly, led by machinery and equipment investment and a recovery in non-residential construction.

 
Risks to the Outlook

The forecast outlined above is the Ministry of Finance and Corporate Relations best estimate of how the economy will perform in the near term. As such, it has roughly equal risks on both the upside and the downside. The report on the Minister's economic conference on pages 10 to 12 outlines the wide range of forecasts that exist for the British Columbia economy in 1997. This underlines the uncertainty associated with any particular forecast.

The upside and downside risks to the British Columbia economic outlook come from both external and internal factors. Higher or lower growth in the economies of the province's trading partners will have an impact on growth in the province. Similarly, internal factors such as consumer spending behaviour and business profitability and investment can affect overall economic growth.

External risk factors:

• North American growth could be higher than expected. Early in 1997, the consensus outlook for economic growth in North America was very positive. U.S. growth was stronger than expected in the fourth quarter of 1996, carrying momentum into 1997. The Canadian economy was also expected to grow much faster than last year. On the other hand, the outlook was not so rosy in Japan, an important market for British Columbia exports.

• Although British Columbia has come a long way in diversifying its economy, commodity export volumes and prices can have a dramatic effect on overall income and profit growth. There is a risk that commodity prices will not recover from last year's declines. Pulp producers and newsprint producers have already delayed scheduled price increases in early 1997 due to continued high levels of inventories.

• Strong economic growth south of the border has increased the likelihood of higher interest rates in the U.S. This could hurt British Columbia lumber exports as housing in the U.S. becomes more expensive. However, the risk of higher Canadian interest rates is low given the large amount of slack in the Canadian economy.

• There is also a downside risk that interprovincial in-migration could be lower than expected. In Canada, stronger growth in other provinces could reduce in-migration to British Columbia resulting in less demand for housing, goods and services. Conversely, international in-migration has been trending up recently and could be higher than expected.

Internal risk factors:

• There is a risk that consumer spending may be lower than forecast due to changing demographics, a greater focus on saving for retirement, or continued concerns about job security. On the other hand, pent-up demand could boost spending more than is anticipated.

• Business profits and consequently business investment may not grow as much as expected. If commodity prices fail to improve, business profits will be lower than forecast. While the interest rate climate for business investment is expected to remain positive, business investment will likely contribute less to overall growth if corporate profits do not grow. Conversely, profits and investment could be higher if export markets and prices improve more than expected.

Budget 97 Reports

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BC Budget 97

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BC Ministry of Finance and Corporate Relations

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