Canada WT/TPR/S/22
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I. THE ECONOMIC ENVIRONMENT
1. Canada 'smacroeconomic indicators haveimproved significantly sincethe1994Trade Policy
Review, although unemployment hasremained high. While GDP growth of4.1percentin1994and
2.3percentin1995(Table I.1)relied essentially onexports, monetary andfiscal policies wereaimed
atrestoring thefundamentals forfuture expansion.1Inflation waskeptlowandthefederal government
budget deficit, asashare ofGDP, isexpected tohalve between 1993/94 and1996/97. Withsluggish
domestic demand andfiscal retrenchment, Canada 'scurrent account improved.
2. Exports benefited notonlyfrom exogenous impulses -exchange ratedepreciation vis-à-vis
theU.S. dollar andtheUnited States 'cyclical lead-butalsofrom significant improvements in
productivity andindustrial efficiency. These, inturn,maybeattributed tothestructural effects both
ofrecession andofthemove towards amore openandlessregulated internal market environment.2
Declining realinterest rates, reduced fiscal deficits andinternal deregulation areexpected tolaythe
foundation forstronger medium-term growth.
(1) Macroeconomic Trends
(i) Production andemployment
3. After strong acceleration in1994, thepaceofeconomic expansion became more volatile in
1995. Theadverse impact onproduction andinvestment ofslackening U.S. demand andhighreal
interest rates inthefirsthalfof1995 were compounded laterbytheuncertainties oftheQuebec
referendum. Thelatter developments further weakened domestic demand which, since1992, hadbeen
lagging behind GDP growth.3Private consumption andresidential investment remained sluggish
throughout 1995, suffering from lowgrowth ofdisposable incomes, highpersonal debtandinterest
payments andafragile labour market.4Aspartofbudgetary consolidation, government expenditure
declined by0.8percentin1994 andafurther 0.3percentin1995.
1According totheOECD, exports contributed almost 5percentage points torealGDP growth in1994. OECD
(1995a), p.6.
2Canada 'seconomic recovery ismore narrow-based than inprevious cycles andhasbeen trailing the
United States. Between 1992 and1995, annual growth rates averaged 2.4percentinCanada, asagainst 3per
centintheUnited States. Bycontrast, overtheprevious cycle, boththeCanadian andtheU.S.economies grew
atanaverage rateof2.4percent(1982 and1991).
3Final domestic demand wasalmost stagnant in1995 (0.7percent).
4Realdisposable income grew by1.1percentin1994 andby1.2percentin1995, while consumer spending
increased by2.9percentand1.4percent, respectively. Higher spending in1994 wasmirrored inareduction
ofthepersonal savings ratefrom 9.2percent(1993) to7.6percent, indicating greater consumer confidence.
Housing starts, which reached 150,000 to200,000 inprevious cycles, averaged lessthan130,000 in1994 and
1995.WT/TPR/S/22
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Table I.1
Performance oftheCanadian economy, 1989-95
1989 1990 1991 1992 1993 1994 1995
(Annual percentage change)
RealGDP 2.4 -0.2 -1.8 0.8 2.2 4.1 2.3
Private consumption 3.4 1.0 -1.6 1.3 1.6 2.9 1.4
Government consumption andinvestment 4.6 3.6 3.0 0.9 0.5 -0.8 -0.3
Private investment 5.7 -4.8 -4.0 -1.7 0.5 5.9 -0.6
- residential 4.8 -9.7 -12.5 7.9 -4.2 1.8 -15.1
- business 6.2 -2.4 -0.2 -5.5 2.7 9.4 5.2
Final domestic demand 4.1 0.4 -1.0 0.6 1.1 2.9 0.7
Realexports (goods andservices) 0.8 4.1 1.4 7.6 10.4 14.2 11.8
Realimports (goods andservices) 6.3 2.0 3.3 5.6 8.8 10.5 9.0
Inflation (CPI) 5.0 4.8 5.6 1.5 1.8 0.2 2.1
Unitlabour costs 5.3 5.4 4.6 1.6 -0.5 -1.4 0.8
Terms oftrade 2.1 -2.1 -1.5 -0.5 0.3 0.5 2.2
Monetary expansion (M2+) 14.0 11.6 8.7 5.4 3.8 2.2 ...
(Percent)
Interest rates(short-term)a12.1 12.8 8.7 6.6 4.8 5.5 6.9
Industrial capacity utilization 80.8 77.8 74.9 76.6 80.5 83.3 84.3
Unemployment 7.5 8.1 10.4 11.3 11.2 10.4 9.5
(PercentofGDP)
Gross savings 10.2 9.5 9.7 10.2 9.4 7.8 7.4
Current account -4.1 -3.8 -4.0 -3.8 -4.0 -3.0 -1.4
... Notavailable.
a Three-month treasury bills.
Source: Statistics Canada (1995), National Income andExpenditure Accounts; OECD (1995a); Bank ofCanada (1995).
4. Therecession of1990/91 tookasevere tollonthelabour market; unemployment peaked at
11.3percentin1992. Subsequent business restructuring contributed tosignificant productivity gains
(Chapter IV(4)(i)), butemployment remained stagnant. Thesituation changed in1994, however, with
anincrease ofover440,000 full-time jobs, thestrongest expansion since 1987. Within 12months,
unemployment came down from over11to9.7percentinthefourth quarter of1994.5However,
thismomentumdissipatedlargelyin1995asaresultofpublicsectorcutbacksandweakeroverallgrowth.
5. Unemployment continues tovarysignificantly between regions, reflecting localspecialization
patterns. Among thehardest hitarethemaritime provinces ofNova Scotia (12.1 percentaverage
unemployment in1995), Prince Edward Island (14.7 percent), andNewfoundland (18.3 percent),
5The"natural"rateofunemploymentisestimatedbytheOECDandtheIMFataround8.5percent.According
totheOECD, itdeclined overthepasttwoyears bysome 0.5to1percentage point because oflabour market
reforms. OECD (1995a).Canada WT/TPR/S/22
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which continue tosuffer from thedecline ofthefisheries sector. Unemployment islowest in
Sasketchewan (6.9percent) andManitoba (7.5percent).
(ii) Fiscal andmonetary developments
6. Chronic over-spending inthe1980'sandshrinking fiscal revenue during therecession ledto
amarked deterioration ofpublic finances inCanada, withadverse effects oneconomic activity. Rising
realinterest ratesstifled private investment, while thedebtcharges limited thescope forpublic action.
(Canada 'slong-term realinterest ratesareamong thehighest intheOECD area.6)Atthesame time,
thecurrent account deficit roserapidly asdomestic savings proved insufficient toreconcile private
investment needs andtheGovernment 'sclaim onresources, anincreasing share ofwhich wasused
forinterest payments (Chart I.1). Between 1983 and1993, non-residents quadrupled theirholdings
ofCanadian government bonds toabout Can$210 billion, e.g.onethirdofthecountry 'stotalpublic
debt. These holdings generated anestimated Can$17 billion innetinterest payments in1993, accounting
for80percentofthecurrent account deficit.
7. TheFederal Government iscommitted torestoring sound public finances; itsfiscal strategy
isbased ontwo-year rolling deficit targets. The1994/95 budget specified aninterim deficit target
of3percentofGDP by1996/97, withacommitment toachieving balance within anunspecified
6While many factors mayinfluence interest rates, fiscal policy plays animportant rôle. Rising public deficits
imply increased competition between theGovernment andprivate investors forcapital, thereby pushing interest
rates up.Although, inanopen economy, capital inflows tendtolimit thiseffect, investors mayclaim arisk
premium when public finances aredeteriorating.WT/TPR/S/22
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timeframe. Thetarget implied asustained reduction inprogramme spending, inparticular, onsubsidies.
Inthe1996/97 budget, theFederal Government announced adeficit target of2percentofGDP by
1997/98 (Table I.2). Thecoincidence offiscal pressures withnewpolicy disciplines under NAFTA
andWTO provisions hasencouraged ageneral reconsideration ofpublic sector responsibilities and
theGovernment 'sinvolvement ineconomic activities (Chapter IV).
Table I.2
Summary statement oftheFederal Budget, 1993-98
(Can$ billion andpercent)
1993-94 1994-95 1995-96 1996-97a1997-98a
Revenues 116.0 123.3 130.6 135.0 141.0
Spending -120.0 -118.7 -113.8 -109.0 -106.0
Operating balance -4.0 4.6 16.8 26.0 35.0
Public debtcharges -38.0 -42.0 -47.0 -47.8 -49.0
Underlying deficit -42.0 -37.5 -30.2 -21.8 -14.0
Contingency reserveb0 0 -2.5 -2.5 -3.0
Deficit -42.0 -37.5 -32.7 -24.3 -17.0
(%ofGDP) (-5.9) (-5.0) (-4.2) (-3.0) (-2.0)
Non-budgetary transactions 12.2 11.6 12.7 10.6 11.0
Financial requirements -29.8 -25.8 -20.0 -13.7 -6.0
Netpublic debt 508.2 545.7 578.4 602.7 619.7
(%ofGDP) (71.3) (72.8) (74.2) (74.8) (73.7)
Notes: Numbers maynotaddduetorounding. Fiscal years arefrom April toMarch.
a Projections.
b Thecontingency reserve isintended toprotect thedeficit target from unpredictable events ormacroeconomic forecast errors.
Source: TheBudget Speech, Department ofFinance, Canada, February 1996.
8. Theprovinces, which account forupto40percentofthegeneral government deficit, arefully
associated withtheconsolidation process.7Seven ofthetenprovinces arecommitted tobalancing their
budgets by1996/97; theGovernments ofQuebec andOntario havealonger timeframe inmind. In
turn,federal andprovincial efforts torestore fiscal balance willfacilitate Canada 'saccess tointernational
credit, withapositive impact oninterest rates, andhelpreduce thelong-standing current account deficit
(Chart I.1).8
7Thegeneral government sector includes thefederal government, provincial andlocaladministrations aswell
ashospitals andtheCanada andQuebec pension plans.
8Concerns about Canada 'sfiscal situation ledMoody 'sin1995 todowngrade therating offederal debtfrom
AAA toAA1.Canada WT/TPR/S/22
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9. Monetarypolicyremainscommittedtoensuringpricestability,withtheBankofCanadatargeting
aninflation bandofbetween 1and3percent. In1994and1995, theconsumer price index remained
below orwithin thisrange (0.2percentand2.1percent,respectively), reflecting theabsence ofwage
pressure andtheavailability ofexcess production capacity.9Thepriceeffects ofcurrency depreciation,
combined withstrong GDP growth inlate1994 andearly 1995, resulted inatemporary increase in
inflation inMay1995 (2.9percentonayear-on-year basis) before moderating again.
10. Reflecting uncertainties overtherecovery andthesizeofmacroeconomic imbalances, both
thenominal andtheeffective exchange rateoftheCanadian dollar wereonadownward trend from
1991 to1995 (Chart I.2).10Appreciation inthefirsthalfof1995 proved short-lived inthewake of
theQuebec referendum; overall, therealeffective exchange ratedeclined byabout 25percentbetween
1991 and1995. Canada 'sterms oftrade improved, nevertheless, asrising commodity prices more
thanoffset theeffects ofdepreciation.
(2) Trade andInvestment Patterns
(i) Trade ingoods
11. Reflecting thedevelopments described above, realmerchandise exports grew atdouble-digit
ratesin1994and1995, pushing theexport-to-GDP ratiofrom31percentin1993toover37percent
in1995 (Tables AI.1toAI.3). Canada 'ssurplus inmerchandise trade increased from 1.3percent
ofGDP in1994 to3.8percentin1995, while thecurrent account deficit shrank toaten-year low
inthefourth quarter of1995 (0.6percentofGDP).
12. Canada 'srecent export boom isattributable mainly tostrong trade expansion with the
United States, thedominant trading partner. Between 1989 and1995, theU.S.share inexports rose
by6percentage points to80percent(Chart I.3).11While thisincrease islikely toreflect avariety
offactors -cyclical developments, exchange ratechanges, bilateral trade liberalization -theparallel
surge inU.S.supplies toCanada underscores theimportance oflonger-term, structural factors. Bilateral
tradeexpansion wasparticularly strong intextiles andclothing, automobiles andcomputers, benefiting
inthecarandelectronics industry from intensive intra-company links (Chapter IV(4)). According
toestimates byIndustry Canada, intra-company tradeofU.S.-controlled firms alone accounts forclose
to45percentofbilateral trade.12
9Thenearstagnation ofprices in1994 ispartly duetoareduction intobacco excise taxes, whose impact
ontheCPIisestimated atminus 1.3percent. OECD (1995a).
10Asnoted inthe1994 TPRreport, exchange ratesinCanada aremarket-determined. There arenoforeign
exchange controls orrestrictions, except those adopted incompliance withUNSecurity Council Resolutions.
However, theBank ofCanada mayinfluence theexchange rateinorder tomitigate fluctuations orhelpmaintain
orderlyconditionsinthemarket,eitherthroughchangesinshort-terminterestratesordirectinterventioninforeign
exchange markets through buying orselling currency.
11SeealsoTable AI.4.
12Industry Canada (1996a).Canada WT/TPR/S/22
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13. Ingeneral, while Canada 'straditional exports -natural resources, related semi-manufactures
andautomobiles -have retained theirrôleinrecent years, higher value-added manufactures have
gradually gained inimportance. After afalloffourpercentage points between 1989 and1993, the
contribution ofnatural resources tototalexports stabilized atonethird(Chart I.4).13
(ii) Developments inservices trade
14. While services represent sometwothirds ofproduction andemployment inCanada, comparable
toother OECD economies, theirshare intrade isdwarfed bygoods. Recording asignificant deficit
intheservices balance, Canada wastheworld 's15thlargest exporter and9thlargest importer of
non-factor services in1994.14Therecent surge inmerchandise exports hasnotbeenaccompanied
byanequivalent expansion inservices, whose share inoverall exports declined from 12percentin
1993 to10percentin1995 (inrealterms). Reflecting theorientation ofmerchandise trade, and
corroborating thesupporting rôleofmany services activities, twothirds ofservices flows originate
inoraredestined fortheUnited States. Travel andbusiness services combined account foronethird
oftotalpayments andreceipts.
15. Astheabove dataarebased onbalance-of-payments statistics, theydonotcapture services
provided through commercial establishment abroad. Given thegradual elimination ofCanada 'spast
restrictionsonforeigninvestmentincoreservicessectors(banking,airtransportandtelecommunications),
thelatter mode ofsupply -covered bytheGeneral Agreement onTrade inServices -islikely tobecome
increasingly important overtime(seealsoChapter IV(5)(i)).
(iii) Foreign direct investment
16. Inward andoutward foreign direct investment (FDI) haveincreased markedly inrecent years.
Between 1989and1995, thestock ofoutward FDIrosefrom14percentto18percentofGDP, while
inward FDIgrewfrom20to22percent. Contrasting withtradeflows, theU.S.share inbothinward
andoutward FDIhasdeclined, although theUnited States remains Canada 'slargest investment partner,
accounting forhalfoftotalinward investment andtwothirds ofCanadian investments abroad. The
share ofbothEurope andJapan hasincreased inrecent years.15Thesectoral composition ofinward
investment shows agradual shiftfrom resource-based toservices sectors.
(3) Outlook
17. Economic activity remained relatively weak inthefirsthalfof1996. Nevertheless, domestic
demand isexpected tostrengthen inthelatter halfoftheyearasthedecline ininterest ratesmakes
itselffeltininterest-sensitive sectors. Current projections forGDP growth areclose to3percentin
1997, contributing toalimited reduction inunemployment. Intheabsence ofsignificant exchange
ratechanges, thecurrent account deficit isexpected tostabilize around present levels. Inflation is
expected toremain within thetarget range astheeconomy continues toshow significant excess capacity.
13SeealsoTable AI.2.
14WTO Focus, No.10,May 1996. Inthiscontext, member States oftheEuropean Union areranked
individually. IftheEUwascounted asoneentity, Canada would bethe8thlargest exporter andthe4thlargest
importer ofservices.
15Canada alsoreceived significant investments from Hong Kong residents.