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1: BRITISH COLUMBIA ECONOMIC REVIEW AND OUTLOOK |
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Overview 1 British Columbia’s economic performance has been mixed so far this year as external conditions have weakened. While the consumer and housing sectors are growing steadily, export and labour markets are not performing as well as expected in the March 15 Budget. Growth abroad has been weaker than anticipated, and prices for many of British Columbia’s exports are lower than forecast. However, long-term interest rates and the exchange rate have been lower than forecast as well.
The weaker external environment has resulted in a lower economic forecast for British Columbia for 2001. This will be partially offset by the effects of the personal income tax cuts that were announced on June 6, 2001, and others announced in this update. The lower personal income taxes should provide some stimulus to consumer demand for the rest of the year. Overall, growth of 2.2 per cent is forecast for 2001. Growth of 3.8 per cent is forecast for 2002, up sharply from the 2.9 per cent in the March 15 Budget. Business and personal tax reductions are expected to lead to an improved business climate and boost investment. Combined with a recovery in the United States, this is expected to place British Columbia’s economic growth rate above the national average. Uncertainty surrounding the timing and strength of the United States recovery and the outcome of the Canada-United States softwood lumber countervail hearing pose the main risks to the forecast. Upside potential arises from the tax cuts and an improved investment climate, which could lead to higher than forecast economic growth. A survey of the Minister of Finance’s Economic Forecast Council was undertaken in June, prior to the business tax cuts announced in the July 30 Update. The survey indicates a consensus forecast of 2.1 per cent this year and 3.2 per cent in 2002 (see Topic Box on page 16). Total exports of goods and services make up over 40 per cent of British Columbia’s gross domestic product (GDP). About 70 per cent of these are destined for international markets, mainly to the United States, while 30 per cent are consumed in the rest of Canada. The United States is leading a global economic slowdown, which is being felt in British Columbia. So far the slowdown is more pronounced and rapid than had been expected in the March 15 Budget. The United States’ economy, which had been operating at or above capacity during the late nineties, slowed rapidly in the last two quarters of 2000. Growth on an annualized basis fell from 5.6 per cent in the second quarter of 2000 to 1.2 per cent in the first quarter of 2001. The slowdown has been concentrated in the manufacturing sector while the consumer sector has remained a source of relative strength. A United States slowdown had been anticipated in the March 15 Budget but had been expected to last only two quarters. It now appears that it will extend at least into the third quarter of 2001. The Federal Reserve Board has reacted swiftly by easing monetary conditions which will hopefully allow the United States to avoid any significant further deterioration.
Outlook: The United States economy is now expected to grow 1.5 per cent this year, compared to 1.8 per cent in the March 15 Budget. The slowdown has spilled over to Asia, which has seen demand for many of its exports fall as a result of declining production in the United States and Europe. Japan continues to wrestle with structural problems in the business sector and persistent price deflation, which have resulted in a decade of economic weakness. In the past, the Japanese government has responded with a program of expansionary government spending but this has proven ineffective, and left Japan with very high debt levels and little fiscal room to manoeuvre. The recent election of a reform-minded prime minister provides some hope for future improvement, but little change is expected in the near term. The Japanese economy is now expected to decline 0.5 per cent in 2001. Europe is also feeling the effects of the United States slowdown. Quarterly growth at an annual rate was 3.6 per cent in the first quarter of 2000 but has fallen to 2.0 per cent in the first quarter of 2001. The European Central bank remains committed to its inflation target and as yet has supplied little stimulus to member economies. Recent economic troubles in Argentina may spill over to other Latin American countries but this is not expected to significantly impact the British Columbia economy.
The impact of the U.S. slowdown will be felt across Canada. Trade with the United States has become increasingly important to all provinces over the last decade, reflecting the trade-liberalization initiatives of the last few years, as well as stronger economic growth. Ontario, in particular, relies heavily on trade in autos and parts with the U.S. British Columbia’s trade is more diversified, and so the province is somewhat less exposed to a U.S. slowdown. Outlook: Canada’s economy is expected to slow in the second half of 2001, but on average will do better than the U.S. with growth of 2.0 per cent for the year. This is unchanged from the March 15 budget. For 2002, Canada’s economic performance matches that of the U.S. at 2.5 per cent.
Financial Markets and Commodity Prices The Federal Reserve Board in the United States has reacted to the economic slowdown by reducing its federal funds rate 2.75 percentage points since January 1 of this year. The Bank of Canada has followed suit but has cut its bank rate less rapidly, a total of 1.50 percentage points from December levels. The July 30 Update assumes at least a further quarter-point cut in the third quarter by the Federal Reserve Board.
The Canadian dollar started 2001 on a downward trend compared to the United States dollar. The dollar flirted with an all-time low in April but has since risen. Given the interest rate spread between Canada and the United States, the forecast assumes a modest appreciation of the Canadian dollar over the next several years. Lumber prices began the year below $US 200 but rose to over $US 360 in May, before levelling off to around $US 270 by mid-July. The end of the Softwood Lumber Agreement on April 1 has created uncertainty in the industry, and British Columbia producers held back on shipments to the United States in order to avoid potential retroactive tariffs. The forecast assumes a modest increase in the average price of lumber to $US 260 this year, with a slight decline expected in 2002. Pulp prices have been falling since the beginning of the year, primarily reflecting reduced North American demand for paper. The forecast assumes pulp prices will decline in 2001 and 2002. Electricity and natural gas prices have fallen from their winter peaks but remain high in historical terms. The market for both these energy sources is heavily influenced by conditions in the United States, and the recent Federal Energy Regulatory Commission decision to impose price caps on electricity sold in the western United States market will likely constrain future electricity prices. The forecast assumes price declines in both natural gas and electricity markets.
The Ministry of Finance Export Commodity Price Index is a weighted average of the prices of 17 commodity groups. As seen in Chart 1.5, British Columbia’s export prices have fallen from their December peak, but are still up 2.8 per cent to May of 2001 from the previous year. The provincial economy has shown mixed results in the face of weaker external conditions. While manufacturing has declined, consumer spending shows steady growth and housing starts continue to strengthen from low levels. The new tax cuts should provide some additional stimulus in the second half of 2001. Real GDP is expected to increase by 2.2 per cent in 2001, down slightly from the 2.4 per cent projected in the March 15 Budget. Further reductions in personal income taxes and cuts to business taxes are forecast to boost the provincial economy in 2002, with growth strengthening to 3.8 per cent.2 Nominal GDP is forecast to increase by 3.6 per cent this year. In 2002, declining prices for energy and other exported commodities are expected to produce an overall 2.1 per cent decline in export prices, resulting in nominal GDP growth of 3.4 per cent.
External Trade The external environment and especially the United States economy have a very large impact on the British Columbia economy. Two-thirds of British Columbia exports to other countries go to the United States. Japan also has a significant impact, receiving about 15 per cent of British Columbia exports.
Through April, the value of international merchandise exports was up 20.4 per cent from 2000. The rise in exports was due to increased energy prices in the United States. Excluding energy products, the value of exports to all countries showed a 4.5 per cent decline. Outlook: Real (price adjusted) exports from British Columbia to all destinations are expected to increase by 1.4 per cent in 2001, lower than the 3.0 per cent March forecast, due to slower growth in the United States and Japan. Export growth is forecast to increase to 4.2 per cent in 2002 as the world economy returns to trend growth. This year, export prices are expected to increase 3.0 per cent, unchanged from March. In 2002, export prices are forecast to fall 2.1 per cent as prices for pulp, newsprint, lumber, natural gas and electricity decline. Real imports into the province are expected to increase by 2.3 per cent in 2001 and by 3.5 per cent in 2002. The growth of imports primarily reflects growing demand for consumer products and investment goods, which are generally manufactured outside the province. Labour Market So far in 2001, labour markets have been soft, with seasonally-adjusted June employment remaining below December 2000 levels. On a year-to-date basis, employment is up 0.8 per cent from the first half of 2000 with growth strongest in the Northeast development region and weakest in the Vancouver Island/Coast development region. With higher growth in part-time employment and less overtime being worked, average hours worked in the first six months of 2001 have decreased 1.9 per cent over last year. Nevertheless, the average weekly wage rate is up 2.5 per cent through May, and first quarter total labour income is 4.9 per cent higher than in 2000. The unemployment rate for the first six months of 2001 was unchanged from 2000, as slow labour force growth has matched employment.
Outlook: Improved job growth through year-end is expected to result in employment growth of 1.5 per cent this year, down from the March forecast of 2.2 per cent. However, the unemployment rate forecast of 7.2 per cent for 2001 is lower than the March forecast, reflecting continued slow growth of the labour force. Next year 3.0 per cent employment growth is forecast, while the unemployment rate is expected to remain at 7.2 per cent. Consumer Spending Consumer attitudes are up for the first half of 2001 Consumer spending has been a bright spot throughout North America so far in 2001. In British Columbia, seasonally-adjusted retail sales were up 5.6 per cent through April. Durable goods, which are one of the first areas where consumers tighten spending, were up 3.8 per cent from 2000 levels. The Conference Board of Canada index of consumer attitudes for British Columbia is up for the first half of 2001, and up a substantial 20 per cent in the second quarter of 2001 compared to the first quarter.
Outlook: On retail sales growth of 4.0 per cent, consumer spending is now forecast to increase 2.4 per cent in 2001, up from 1.8 per cent in the March forecast. The recent provincial personal income tax cut is expected to raise personal disposable income, translating into stronger consumer confidence and higher spending. Next year, consumer expenditures are expected to grow 2.9 per cent. Business Activity and Investment Manufacturing shipments from the province are down 6.9 per cent so far this year. The United States slowdown is having a noticeable effect on manufacturers due to the sizable portion of British Columbia goods dependent on United States markets. Business bankruptcies are up 8.1 per cent through May, and a series of disappointing profit announcements have dampened expectations. Statistics Canada’s second quarter business conditions survey showed that British Columbia manufacturers were slightly less optimistic about the prospects for the next quarter than they have been recently. Despite these indicators, business investment appears to be picking up. Non-residential building permits during the January to May period have increased 12.7 per cent over the same period last year. Because of weak population growth, British Columbia home construction has been slow for several years. However, housing starts are now showing some signs of improvement. Through June, total housing starts in the province are up 18 per cent from last year’s levels and the upturn in residential building permits suggests a continuation of this trend. The upturn in the housing market has affected not just starts but the market for existing homes as well. Multiple Listing Service data show that sales of existing homes are up 15.6 per cent through May compared to last year. All aspects of the housing market have benefited from monetary easing by the Bank of Canada, which has led to lower mortgage rates for homebuyers. Statistics Canada’s survey of Public and Private Investment suggests an increase in total British Columbia investment of 3.5 per cent for 2001 compared to 2000. This is a significant increase over the February survey, which showed a 1.2 per cent decline.
Outlook: Corporate pre-tax profits are projected to grow 5.0 per cent this year, but remain flat next year as export prices decline. The expected decline in 2002 was more pronounced in the March forecast, despite a generally higher forecast of export prices. The relative improvement in the current forecast is a result of business and personal tax decreases. Overall, capital investment is projected to increase 3.3 per cent in real terms this year, with growth in machinery and equipment investment of 5.0 per cent. Non-residential construction investment is forecast to increase 3.2 per cent this year, while residential investment growth is projected at 4.2 per cent. Reductions in business taxes include the corporation income tax, the corporation capital tax and the social service tax on certain investment goods. These tax reductions are designed to generate a more competitive tax environment, which in turn will stimulate investment and the overall performance of the provincial economy. Investment is forecast to grow 6.2 per cent in 2002, spurred by higher machinery and equipment purchases and non-residential construction activity. Improved economic performance and a more competitive tax environment should also help to draw people to British Columbia. In-migration is expected to rise to 26,900 this year and to 50,700 in 2002, as interprovincial flows return to the positive levels of the mid 1990’s In response to higher in-migration and some pent-up demand, housing starts are projected to rise to 15,600 units this year, increasing to 16,660 units in 2002. Government Sector Outlook: In inflation-adjusted terms, government spending at federal, provincial and local levels is expected to rise 1.6 per cent in 2001, primarily as a result of increased federal and provincial government spending. Inflation During the first five months of the year, consumer price inflation in British Columbia averaged 1.9 per cent. Much of the increase in the overall price level can be attributed to higher energy prices, primarily natural gas and gasoline, as well as higher prices for fresh fruit and vegetables. Energy prices appear to be heading down after recent peaks but are expected to remain relatively high in the near term. Outlook: The inflation rate is forecast to increase to 2.0 per cent in 2001, up from 1.7 per cent in the March forecast. As energy prices ease off next year, the inflation rate is projected to fall to 1.6 per cent.
The extent of the United States downturn and its impact on British Columbia and other provinces are the main risks to the forecast, in particular if the United States slowdown is longer than expected. The policy responses to the slowdown by the United States and Canadian governments, as well as the Federal Reserve Board and the Bank of Canada, are key to a stable recovery. Larger than expected interest rate reductions could provide additional short-term stimulus, though at a potential cost of increased medium term economic volatility. The outlook for export prices provides another area of forecast risk due to the volatility of natural gas and electricity prices, and uncertainty surrounding the outcome of the softwood lumber dispute with the United States. Deregulation and business tax cuts should lead to an improved investment climate and rising business and consumer confidence in British Columbia. In combination, these provide upside potential to the forecast expansion of consumer spending and business investment. The Medium Term Outlook 2003–2005 Real GDP growth in both Canada and the United States are forecast to average just under 3.0 per cent in the medium term. The combined impact of tax cuts and the recovery in Canada and the United States is expected to result in continued economic expansion in British Columbia. Strong growth in investment coupled with robust consumer and residential sectors should give British Columbia solid economic growth over the 2003–2005 period. This economic activity in turn is expected to produce strong labour income growth and a much-improved performance on the corporate profit front. Job creation should remain on track and, coupled with renewed growth in the labour force, the unemployment rate is forecast to gradually decline to 6.5 per cent by the end of the period. The improved economic climate is expected to draw more people to the province, increasing the population by an average of 1.7 per cent a year. After lagging the country in the late 1990s, provincial real GDP is forecast to grow at an average rate of nearly 3.0 per cent a year for the period 2003 –2005, equal to the forecast Canadian average for the period.
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