Business

THE EDGE OF THE KNIFE

SLUMP OR NO SLUMP, THIS ECONOMY CUTS BOTH WAYS

MARY JANIGAN July 23 2001
Business

THE EDGE OF THE KNIFE

SLUMP OR NO SLUMP, THIS ECONOMY CUTS BOTH WAYS

MARY JANIGAN July 23 2001

THE EDGE OF THE KNIFE

SLUMP OR NO SLUMP, THIS ECONOMY CUTS BOTH WAYS

MARY JANIGAN

Business

Linda Pickard knows all about the bad news. As a consultant, she tracks the economy like a terrier. She knows that her clients have cut back on their travel and

advertising. She has friends who have lost their jobs at Nortel Networks Corp. Her own stock portfolio is not looking very pretty. But she just can’t reconcile those dire events with her own business: her tiny strategy consulting firm, which she operates out of her Mississauga, Ont., home, is thriving. Profits in the first six months of this year are comfortably above those in the same period last year. She wonders what is happening out there. How has she dodged this economic bullet? “Life goes on despite the high-tech meltdown,” she

says warily. “My business didn’t overheat or get caught up in the hype. We have just been growing steadily.”

Welcome to the world of the selective downturn. For months, as Canadians held their breath, employment and growth in the manufacturing sector have steadily shrunk. The toll has been terrible:

in the first six months of this year, 53,000 manufacturing jobs vanished—including

11.000 last month. But while the economy has gone flat, it has not slipped into outright decline. Consumers have kept spending—and they represent roughly 60 per cent of GDP. Optimism among the

100.000 members of the Canadian Fed-

eration of Independent Business remains strong. Construction is booming. The service sector is buoyant. Even as the downturn has spread to Europe and Japan, the gloomy Canadian news has remained largely confined to a handful of sectors such as telecommunications and automobiles. The balancing act has been electrifying. “The economy is still on a knife-edge in North America,” says Doug Porter, senior economist at BMO Nesbitt Burns Inc. in Toronto. “I am a little more optimistic—but the evidence is still quite mixed.” That guardedly upbeat approach is probably justified— because the U.S. economy appears to be creeping back from the brink. And since Americans bought 85 per cent of Canadas exports last year, experts on both sides of the border have their fingers crossed. The U.S. economy has shown the same narrow weakness as Canada’s: last month, 113,000 of the 114,000 U.S. jobs that disappeared were in manufacturing. But good news is emerging: the rate of decline in economic activity actually slowed last month—and in-

ventories are disappearing fast.

Economists are now pinning their predictions for recovery on two factors: the U.S. Federal Reserve Board has cut its key interest rate by a total of 2.75 percentage points this year—and recent tax cuts have put $110 billion in consumers’ pockets. The resulting spending may pull manufacturers out of their slump. “Recovery will come by the fourth quarter,” predicts Don Drummond, chief economist at the Toronto-Dominion Bank. “But there are going to be some ugly times before then.” The economy may have hit bottom— but it is not bouncing sharply back. In the past few weeks, hundreds of U.S. and Canadian firms such as Nortel have issued warnings about slumping second-quarter earnings. Investors have become skeptical—and stock markets remain weak. “Investors are saying they don’t think corporate profits are going to pick up any time

THE JOBS PICTURE Employment gain or loss since each economy started slowing down (per cent, annualized) j Manufacturing f sfc rnmary inausiries Âlf Employment 'Includes mining, resources and farming in Canada; mining only in United States Data from January to June, 2001, for Canada; August, 2000, to June, 2001, for the United States Source: Statistics Canada. U.S. Bureau of Labor Statistics, CONSUMERS HANG IN Spending growth (per cent, annualized)

soon,” warns Katherine Beattie, technical analyst at Standard & Poor’s MMS.

The upturn, in fact, will likely be just as uneven as the downturn. Canadian economic weakness has centred on the automotive industry, the high-tech and communications sector and some primary resource industries such as forestry. Automobiles are now slowly reviving. Because of generous offers to customers, the lots filled with unsold cars have disappeared— although sales will likely remain well below last year’s booming levels. The market for telecom products like Nortel’s, in contrast, remains pitiful because business investment has plummeted: output of such equipment dropped by a staggering 33 per cent between October and March.

The spillover effect has been dramatic. Jay Myers, chief economist for Canadian Manufacturers & Exporters, a 3,000member Ottawa-based association, points out that the high-tech meltdown has hit the pulp-and-paper industry: newsprint sales have declined in part because battered e-commerce firms are no longer running

flashy newspaper ads and churning out glossy inserts. “So many different sectors were tied to high-tech stocks,” he says.

It is those deep connections spanning industries and nations that inspire caution. David Rosenberg, chief economist at Merrill Lynch Canada Inc., points out that the economies of Europe and Japan constitute more than a third of the worlds GDP So no one can be confident about Canada’s prospects as Europe slumps and Japan faces decline. “The risk is not: does Canada go into recession?” Rosenberg says. “The question is: do such factors outside our borders limit the eventual upturn?”

Worse, the most unnerving lesson from this slowdown is how much those connections have increased. It’s not just declining trade flows that have hit Europe and Japan. Instead, TD Bank economists have concluded that the flow of money is responsible for much of the downturn. Foreign direct investment in the United States—that is, investment that secures a managerial role, rather than a speculative stake, in an enterprise—increased by almost 40 per cent per year between 1995 and 2000. Those operations are concentrated in manufacturing, generating 13 per cent of all U.S. jobs in that sector. So when U.S. manufacturing slowed, foreign parent firms were also hit: in response, they often curbed their domestic operations as well. U.S. slumps are now global slumps. And U.S. consumers may be global saviours.

There is an irony here. As economist Drummond notes, when the U.S. Federal Reserve began to raise interest rates in 1999, its goal was to curb consumption, to allow household debts to dwindle and savings rates to rise—and to check the keen U.S. appetite for imports. In theory, inflation pressures would abate—and capacityenhancing investment would grow. Instead, now that interest rates are low again, it’s clear that the opposite has happened. Consumption remains robust. Debt burdens are high. Savings are insignificant. The trade deficit is at a postwar high. Investment to enhance growth has collapsed. “We are going to come out of the cycle with problems that are worse than when we went in,” Drummond warns. The recovery may be sputtering to a start—but there is little reason to cheer.

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