Historic free trade agreement should spark investment, leading to substantially greater U.S. exports in 1988 - U.S.-Canada Free Trade Agreement

Business America, Jan 18, 1988

Historic Free Trade Agreement Should Spark Investment, Leading to Substantially Greater U.S. Exports in 1988 Canada continues to achieve strong economic growth. Following a cyclical downturn in the second half of 1986, the Canadian economy rebounded vigorously in the first half of 1987. This unexpected turn of events set the stage for growth projections of roughly 3.5 percent for the entire year (compared to 3.3 percent in 1986), easing to around 3 percent in 1988.

For 1986-88, Canada will have one of the highest growth rates among major developed countries. Economic expansion is expected to be more evenly distributed in 1988, both regionally and sectorally, than in 1985 or 1986. In 1986, the national economy was fueled by consumer spending and the external sector.

While both should continue at a respectable rate in 1988, private investment should take the lead. Major capital expenditures on plant modernization should sustain significant growth in spending on machinery and equipment. Nonresidential construction shows signs of expansion, not only in the industrial and commercial sectors, but in the oil and gas sector as well. Residential construction continued to boom in early 1987, but will ease throughout 1988.

The contribution of the government sector to GDP should continue to contract slightly. Tax reform is likely to be mildly stimulative in 1988 as consumers benefit from lower income tax rates. Canada's trade surplus in 1988 is projected to increase, and a modest decline should occur in the current-account deficit.

The strong macroeconomic growth performance in the first half of 1987 had a very favorable impact on employment. Full-time employment rose by 3.3 percent. While the bulk of employment gains came from Central Canada, Atlantic Canada also began to show substantial employment growth. Canada's unemployment rate should decline considerably over the forecast period, from 9.6 percent in 1986 to 9.2 percent in 1987, dropping to under 9 percent in 1988.

Inflation, on the other hand, has been a problem. Rather than declining to 3 percent as predicted by the Department of Finance, consumer prices rose more rapidly in 1987 than in 1986. The annual rate was expected to increase to 4.5 percent in 1987 and is likely to reach 5 percent in 1988.

The Bank of Canada has restrained monetary growth in response to a slight increase in inflation, such that interest rates rose marginally through 1987. They are expected to remain steady in 1988. The policy objective will be to sustain interest rate differentials of 200 to 300 basis points relative to corresponding U.S. rates on short-term instruments, on the assumption that this will be adequate to contain inflationary pressures and expectations and preclude exchange rate depreciation.

Regional Outlook

New foundland's economy grew by about 2 percent in 1987; the forecast for 1988 is a little over 1 percent. The performance of the resource-based economy (fishing, forestry, and mining) is expected to be mixed. While offshore fishing activity is expected to continue at the busy pace set in 1986, with prices remaining high, the inshore fishery (the larger of the two) is still experiencing difficulty. Newsprint production and mining output are expected to be at satisfactory levels in 1988, but offshore petroleum exploration has declined, with little improvement expected in 1988. Total employment is expected to grow by under 2 percent over the next year. As a result, Newfoundland's 20 percent unemployment rate (the highest in Canada) is expected to decline only marginally in 1988.

Prince Edward Island's economy is forecast to expand by around 2 percent in 1988, following real GDP growth of 4.5 percent in 1986 and 2 percent in 1987. Output declines in construction, government, and defense will be the prime contributors to the slowdown, and unemployment is expected to stay over 13 percent. On a more positive note, tourism is expected to exceed 1986's outstanding performance. In addition, prices and output in the province's two largest export industries, fish and potatoes, are at high levels and will likely remain so over the next year.

Growth in Nova Scotia is expected to remain near 1986's rate of 2.2 percent. The province's economy is fairly diverse, so while the offshore energy sector will remain stagnant, the fishery, forestry, and tourism industries should perform well. Manufacturing production is expected to remain weak, along with residential and nonresidential construction. Consequently, Nova Scotia's unemployment rate is not expected to decline from the 1986 rate of 13.4 percent. However, there will be increased attempts to rejuvenate the economy of the Cape Breton region through intensified federal government incentive programs.

New Brunswick should have the strongest economy in the Atlantic region in 1988. Forestry activity is expected to expand at a fast pace because of robust pulp and paper production. Metal mining production should recover from the downswing in 1986, but the proposed U.S. countervailing duty on Canadian potash might create problems for the New Brunswick industry in 1988. Manufacturing production should continue to expand, with construction of government frigates providing an impetus. Overall, New Brunswick's economy grew by about 3.5 percent in 1987, following 3.4 percent in 1986, and should ease to 2.5 percent in 1988. The provincial unemployment rate is expected to drop from around 13.4 percent in 1987 to 12.7 percent in 1988.