The recovery takes shape

James Fleming July 18 1983

The recovery takes shape

James Fleming July 18 1983

The recovery takes shape


James Fleming

The meeting was hastily planned, poorly attended and, as most participants agreed, amounted to a simple exercise in public posturing. When federal Finance Minister Marc Lalonde gathered with his provincial counterparts—or their stand-ins—for a one-day meeting on the economy in Montreal last week, little of substance was discussed. Complained Quebec’s Jacques Parizeau: “In all my years of attending such events, I have never seen the equivalent waste of time.” Despite the apparent irrelevance of the meeting, however, the ministers shared a nagging worry as they chatted generally about the slowly recovering economy: will it last?

Like most Canadians, the politicians have watched the agonizingly uneven turnaround with trepidation and hope. Now that the recovery is undeniably in progress, the doubts fed by almost two years of economic hardship are not easy to shake. Chief among those worries is interest rates that have not fallen to keep pace with inflation, producing historically high “real” interest rates. Said one federal official: “The biggest fear of the politicians—the thing they won’t discuss publicly—is interest rates.” In fact, the prospect that real interest rates will stay at unprecedented lev-

els—or worse, rise in the coming months—is the foremost of several major threats to the recovery now under way.

Nothing less than the nation’s longterm health is at stake. Sparked by the already substantial drop in the cost of money in recent months, an upturn is taking hold in varying degrees in Canada and around the world. So far, the optimism is spelled out on computer printouts, crammed with arcane summaries of leading indicators. But it has also taken tangible form in auto and appliance showrooms and on factory assembly lines and residential construction sites. Throughout North America and abroad, businessmen and consumers are gradually regaining the confidence they lost during the 18-month recession.

Whether or not the rejuvenation will last, however, is a major question. Interest rates are the main factor bedevilling optimistic scenarios. With inflation at 5.4 per cent and interest rates of 11 per cent, the 5.6-point spread is the largest in history. It would defy all economic theory, troubled experts submit, if the continuing high cost of money did not eventually snuff out a lasting revival. Yet the prospect of lowering rates concerns monetary authorities, who fear that such action would re-ignite inflation. There are other troubling spectres. One is the possibility that the

unabated insolvency crisis in the Third World might force developing countries to abandon their debts. That, in turn, could lead to the collapse of their major lenders, the multinational banks, and thereby cripple the recovery. Another obstacle to economic growth in the long term is the rising plague of international trade protectionism. Yet for Canada, whose productivity has lagged seriously behind that of its trading partners, freer trade also poses a serious challenge: how to meet increasing competition for world markets. But now the most pressing issue is whether the nascent recovery will last. Warns Thomas Maxwell, chief economist with the Con-

ference Board of Canada: “What’s cooking now is a one-shot deal.” The real question, he adds “is whether the cyclical rebound now under way will be translated into a sustained recovery.” There is no doubt that the world economy has been rejuvenated after the abysmal lows it reached in 1982. The spark behind the upturn was a decision in mid-1982 by U.S. Federal Reserve Board Chairman Paul Volcker to pull back on the levers of monetary restraint. As a result, the money supply expanded—at a 14-per-cent annual rate—and prime interest rates dropped in the United States from a high of 20.5 per cent in September 1981 to last week’s 10.5 per cent. Although many

people feel that is still too high, the reduction did its work: the signs that the U.S. economy is recovering are indisputable. Housing starts, a traditional bellwether of the strength of any recovery, showed a strong three-percent gain in May. The surge is spreading to other sectors as well. Industrial orders, purchasing and employment have risen. Auto sales, which Detroit had expected to rise at an annual 15-per-cent rate, are actually rising by 20 per cent. But the greatest joy in the U.S. economy is in the retail sector. It has seen a 2.1per-cent rise over last year—and the same trend has been reflected in Canada. Albert Sommers, chief economist of the U.S. Conference Board, sees more than a recovery; he senses a boom. Noting that “retail trade has turned decisively, powerfully, maybe explosively, upward,” Sommers said that many forecasters are only now beginning to “come to grips with the size of the boom.”

President Ronald Reagan is a belated

optimist. His June 28 announcement that the official growth estimate was being boosted to 5.5 per cent—from 4.7 per cent—was, if anything, cautious. Some private forecasters now predict a seven-per-cent growth rate by late 1983. Spurred on by the U.S. upturn, Washington’s major trading partners have also enjoyed the taste of recovery. In the past six months Western European nations, led by Great Britain and West Germany, have experienced a moderate increase in production, consumer spending and investment, although there are now more than 11 million jobless in the European Community.

Meanwhile, Japan’s already robust economy is poised to get even stronger

this year. A battery of prestigious think tanks all predict record exports for Japan, a steady growth in GNP of between three and four per cent and continuing low inflation of less than three per cent.

In Canada the signs of a budding recovery also have proliferated since the first quarter of the year. At last, some optimism has been restored after the painful experience of 1982. Then, nervous consumers hoarded away an unprecedented 14 per cent of their income in savings amid fears that they, too, could lose their jobs. Businessmen, in turn, have emerged hesitantly from a cocoon of pessimism after suffering a record 10,765 bankruptcies during 1982, plummeting sales and vanishing profits. In total, the nation’s GNP shrank by 4.4 per cent last year, the worst contraction among industrialized nations in the 12-month period.

By contrast, during the first quarter of 1983, Canada’s GNP rose in real terms by an annual rate of 7.3 per cent. In the consumer sector the main progress has been in durable goods, particularly automobiles, which had a 21-per-cent jump in sales. At the same time, appliance sales rose by 16.7 per cent in the first four months of 1983 over the same period in 1982. Housing starts also began an upward march in the first five months of 1983, reaching a 256,000 annual rate in May, though the pace slackened in June to 180,000.

There has been other refreshing news on the industrial front. After a massive liquidation of business inventories in the final months of 1982, the first three months of 1983 saw a six-per-cent increase in industrial production. Business profits also recovered from the terrible performance during the 18-month-

long recession when they dropped 46.7 per cent. In fact, between January and March they rose by 22.5 per cent.

While computer terminals disgorged the hopeful statistical evidence, the nation’s stock markets heralded the recovery in a much more dramatic way. Since August, when the exchanges first puzzled skeptical pundits by staging a turnaround, Canadian markets, like their international counterparts, have roared upward. Last month the Toronto Stock Exchange completed its best 12-month surge in 50 years. The TSE 300 composite rose from 1366.8 in June, 1982, to 2430.9 on June 29 this year, a 77.85-per-cent hike. And while the value of Canadian stocks listed on the TSE jumped by $70.55 billion in the period, stocks on the Vancouver Exchange increased by $334 million, and those on the Montreal Stock Exchange by $274.6 million.

But while euphoria dominates the stock market and leading indicators continue to be upbeat, key sectors in the economy are still waiting to take part in the celebration. Calvert Knudsen, chairman of the British Columbiabased lumber giant MacMillan Bloedel Ltd., is not very impressed by talk of an upturn. “Outside housing, as far as our industry is concerned,” he says, “the recovery is still very fragile.” Indeed, while the North American housing boom has boosted demand for lumber, the market for other forest products remains stagnant. As far as worldwide demand for pulp is concerned, says Knudsen, “it appears that the worst is over, but there are no signs of recovery yet. In newsprint, which is a major product of Eastern Canada, the conditions are still very depressed because of very substantial worldwide overcapacity.”

Mining executives also have little cause for relief. Says Alfred Powis, chairman of Toronto-based Noranda Mines Ltd.: “Everybody talks about this recovery, but we haven’t seen it yet.” Although prices for copper and zinc, which are used in cars and houses, are improving as a whole, he cautions that demand remains very soft. The oil and gas industry is even more uncertain. Plummeting world oil prices have left the industry in Western Canada in an anemic condition. But in Nova Scotia, where a flurry of offshore exploration is expected this year, consumers are already savoring the spin-off effects. Says Gordon Lummis, executive vice-president of the Halifax Board of Trade: “You can almost feel the attitude about the economy change. People are suddenly optimistic again.”

And while manufacturers have felt the effects of increased demand for durable goods in particular, the nation’s textile makers remain skeptical. Says Raymond Chevrier, president of the textile group for Montreal-based Celanese Canada Inc.: “We have seen a rebound in sales of polyester, especially for industrial uses, but certain segments are weak, such as broad woven polyester fabrics used in apparel.” Despite such problems, federal politicians have chosen to emphasize the recovery’s strengths. As Prime Minister Pierre Trudeau recently put it in a nationwide broadcast: “We are passing from recession to restored prosperity. Our country is moving forward again.” Still, economists are skeptical about claims by the federal government that its Six-and-Five restraint program was mainly responsible for the cooling of in-

flation—in May consumer prices were only 5.4-per-cent higher than in May last year. If the government is responsible for the drop in inflation from a peak of 12.7 per cent in 1981, it is not because wage gains were held down last year but mainly because Ottawa joined U.S. authorities in tightening the money supply. Prime interest rates in Canada rose to 22.5 per cent in August, 1981, before dropping to 11 per cent last week. What is more, the social costs of the contraction have been difficult to quantify, although an unemployment rate of 12.2 per cent is the worst of all indications. Says Wendy Dobson, executive director of the C.D. Howe Institute:

“While great progress was made on inflation during the downturn, the cost was very high in human terms, in productive capacity that was not put to use and in bankruptcies.”

Indeed, with 1.5 million people unemployed in Canada, it is all the more crucial that the current cyclical recovery be sustained in coming years. But the threats to its durability are troubling. According to Michael McCracken, president of Informetrica Ltd., an Ottawabased forecasting firm, interest rates are still too high for many would-be borrowers. Says McCracken: “Interest rates should be two percentage points lower, but they won’t move down unless inflation is further reduced.”

The Conference Board’s Maxwell is more blunt. “Economists are too bloody rational,” he says. “They sit there and say what really counts is the difference between interest rates and inflation.” What people don’t recognize, he adds, is that there is a lag in perception. “Right now,” he says, “the householder is comparing a 12-per-cent mortgage rate to the 18-per-cent rate he was carrying a year ago. After a while he will realize that 12 per cent hurts when his wages are only rising by five per cent.” When that realization sinks in, consumer confidence and spending will contract, says Maxwell. The main threat to the recovery, he asserts, is real interest rates. “If they don’t come down, you won’t see a sustained recovery.” On that score Maxwell is pessimistic. Interest rates are not likely to fall, he predicts, because the financial community believes that i any stimulus now, which would be rei fleeted in higher government deficits or

in the rapid growth of the money supply, will result in future inflation.

In fact, most financial experts expect interest rates to stabilize in the coming months as Volcker coaxes the U.S. recovery along. But there is another major incentive for Volcker not to let the cost of money rise: the continuing insolvency crisis faced by the developing world. While the debt problems of Argentina, Brazil and Mexico are the most severe, at least 34 nations have rescheduled, or are in the process of rescheduling, payments on their foreign debt. At stake is the solvency of some of the world’s largest banks, particularly those in the United States that have extended the lion’s share of credit. If several developing nations refuse to pay off their debts, widespread bank failures would follow. That, in turn, could abort the recovery. As Volcker put it last week, “Failure to manage and diffuse these strains could deal a serious blow to the recovery of the United States and the world economy.”

In the longer term there are other obstacles to world economic growth. During the recent recession, for instance, the value of world trade dropped to the levels of 1979.

At the same time, protectionist measures, including tariffs, voluntary export restrictions and state subsidies for struggling industries, have proliferated. The industrial nations have sparred over trade barriers in everything from agriculture to autos and

high-technology products. And last week a bitter new row erupted when President Reagan announced a fouryear program of tariffs and import quotas to aid domestic specialty steel manufacturers. That move brought immediate condemnation from the European Community, whose officials said that it would affect exports worth $150 million a year and seriously damage Europe’s beleaguered steel industry.

While protectionism has become a growing menace to the growth of world trade, the alternative—a move to even freer trade, as the General Agreement on Tariffs and Trade would have it— also poses a major challenge for the industrialized nations. Canada, in particular, must deal with a productivity crisis that, if left unresolved, will cripple its ability to compete for world markets. The extent of that crisis was made clear last month by the Economic Council of Canada. In its report, The Bottom Line: Technology, Trade and Income Growth, the council warned: “Productivity has not grown in Canada for eight years now. That situation is unprecedented, and potentially disastrous for living-standard growth.” While productivity, as measured by output per worker, advanced between 1950 and 1973 at an annual rate of 2.6 per cent, from 1973 to 1981 average productivity growth was zero. The council dismisses the notion, however, that the fault lies with lazy or unproductive workers. The blame rests, it says, with protective trade barriers and the use of outdated equipment by industry.

Federal Economic Development Minister Donald Johnston largely agrees with the council’s diagnosis. Workers

are not the cause of poor productivity. “Our people are just as good as anybody else,” he says. “Our productivity must be improved,” he adds, “by making sure that we are able to create a quicker diffusion of emerging technologies through Canadian industries to allow them to become—or to remain—competitive.” People tend to look to the future in such areas as telecommunications and computer terminals, says Johnston. “We are fairly strong in those areas,” he concludes. “Where we must be even stronger is in using the latest technologies in our traditional industries—fishing, farming and forestry.”

In the United States a debate is growing over whether the government should adopt an overall industrial policy, a grand design that specifies which industries to promote for the global competition and which to let die. This is necessary, argue a growing number of politicians, so that the United States is not left behind in the economic race with Japan and the Western European nations, where industrial policies are already in place. But Johnston eschews this politically unpopular approach. His aim is to develop “framework policies which allow Canadian industries to respond to market challenges. They shouldn’t be handed down like tablets.” How Ottawa fares in its bid to restore productivity growth will have a major impact on the long-term prosperity of Canadians. But now they face a much more immediate test. Canadians, says Dobson, “face one of the most important economic challenges since the Great Depression.” That challenge, she says, is to discover how Canada got itself into such difficult times. While Dobson places much of the responsibility for Canada’s travails on confusing government policy, consumers also bear responsibility. “The lessons have to do with how expectations are formed, what we can pay ourselves and of what the economy is capable of delivering.” If the recovery gains lasting momentum, Canadians may be in a position to take Dobson’s advice. Until then, their fate rests largely in the hands of policymakers who must cope with interest rates, the international debt crisis and growing trade protectionism. How these issues are dealt with will determine whether or not the current upsurge will be a lasting one.

Carol Bruman

Mary Janigan

William Lowther

Peter Lewis

Peter McGill