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Monthly Economic Letter

February 2018
Feature article

Are wages going to pick up steam in 2018?

Canada’s economy grew impressively in 2017, creating over 420,000 new jobs during the year. As of January, the national unemployment rate has fallen to 5.9%. If the labour market is tightening, then we would normally expect wages to rise as bargaining power moves into the hands of workers. However, we haven’t seen a strong upward move in wages and we believe this is due to structural changes in the economy. Nevertheless, entrepreneurs should be preparing themselves for more pressure for wage increases this year.

Labour demand has been strong, especially in certain sectors

Despite the increase in hiring last year, the number of unfilled advertised jobs remains high, hitting 468,000 nationally as of the third quarter of 2017, with the biggest increases in Quebec followed by British Columbia and Ontario, according to Statistics Canada.

Many businesses are concerned about labour shortages. Over the past five months, roughly 60% of small business owners have consistently reported that shortages of both skilled and low or unskilled workers are limiting their production and sales, according to the Canadian Federation of Independent Businesses (CFIB).

While there is much variation between provinces, the sectors with the strongest demand for labour include manufacturing, transportation and warehousing, accommodation and food services, and healthcare and social assistance.

Labour supply has been slowing

Baby-boom generation workers are retiring, and the next generations coming up to replace them are smaller, creating a gap.

The younger cohort—the Millennials and Generation Z (those born after 2000)—represents close to 50% of the working age population. One reason keeping wages low for this cohort could be that they are still developing their experience and may not be in the best bargaining position to demand pay increases.

The phenomenon of a large retiring generation and a smaller replacement generation is more acute in some provinces than in others. In Quebec, Nova Scotia, New Brunswick and Newfoundland, the working age population has actually been declining over the last few years, and a reversal is unlikely unless immigration picks up significantly.

If the labour market is tightening, why haven’t wage increases been stronger?

Three factors weighing on wage growth

  1. Technology and globalization have changed the labour market: Labour markets in developed countries have changed over the past 20 years due to advances in technology and the impact of globalization. While the automation of many routine tasks has made businesses more efficient, it has also reduced the number of workers required for a given level of production. The combination of automation and offshoring production to lower cost countries has resulted in the decline in middle-skill jobs. Many of the workers in those jobs have either left the labour force or found part-time work and temporary contracts in lower skill jobs, and an increasing proportion of which are in the services sector. This phenomenon has contributed to some downward pressure on wages.
  2. Slow productivity growth hinders wage growth: Once an economy is at or near full employment, a key driver of wage gains is the trend in productivity growth. Higher labour productivity increases firms’ profitability and eventually leads them to add more workers to continue growing their business. With higher profitability, companies can offer higher wages to attract the new workers they need. Canada’s annual productivity growth has averaged an anemic 0.4% since 2011, far below the 3.2% of the 1960s and the 1-2% from 1970 to 2010, according to analysis by Desjardins. This slow growth has hindered wage growth.
  3. Workers’ smaller share of returns from growth: Labour’s share of Canadian GDP has declined from 61% in 1991 to 56% in 2013, similar to trends in other developed countries, according to the International Labour Organization. This means that today, when firms’ productivity and profits improve, a greater proportion goes to shareholders, as opposed to workers, than in the past, keeping downward pressure on wages.

Why wage growth ought to strengthen in 2018

While changes in the structure of the labour market have kept downward pressures on wages over the past number of years, the strengthening economy is steadily reducing the number of underutilized workers, i.e., “labour market slack” such as people working part-time but who would prefer full-time work. A sign that the labour market slack is being absorbed is that over 90% of the jobs created in 2017 were full-time jobs. This year, we expect that the combination of the absorption of this labour market slack and the demographic challenge posed by the retiring baby-boom generation will outweigh the structural changes (discussed above) and that will put upward pressure on wages.

To wit, a survey by CFIB in January indicated that about 40% of businesses expect to raise wages by 3% or more over the next 12 months, with the majority expecting to raise wages by 5% or more.

Besides pressure from a tighter labour market, minimum wage hikes across the country are also driving wage increases, most significantly in Ontario, Alberta and Quebec. When wages rise for the lowest paid workers, those earning close to that wage also receive increases. Minimum wage increases will likely result in raises for about 11% of Canada’s workers, according to the Bank of Canada.

Bottom line

Wages should increase for workers, especially in sectors in high demand such as finance, real estate and wholesale trade. The provinces with the strongest demand and the smallest working age populations will experience the most intense pressure for higher pay, namely Quebec, British Columbia and Ontario (see graph). However, the strength and duration of pressure for higher wages will depend on whether investments in capital and skills training generate higher labour productivity and greater economic growth.

What does it mean for entrepreneurs?

  • Be ready to raise wages and offer more benefits to employees, especially when you are operating in a sector where talent is in demand.
  • Invest in technology and training to enhance the labour productivity of your workers to ensure your workforce stays competitive.
  • Understand the demographics for your available labour pool to anticipate changes in wages in your industry moving forward. Check out Statistics Canada’s Age Pyramid comparison tool for your metropolitan area.
  • Read what other entrepreneurs are doing to manage in this challenging labour market in BDC’s report: Future-proof your business—Adapting to technology and demographic trends.
Canadian economy at a glance

Nearly all sectors of Canada’s economy are growing, with oil and gas leading the way

The strengthening global economy and the recovery in oil prices are fuelling a broad-based expansion across the country. The Canadian economy grew 3.4% over the first 11 months of 2017, compared to the same period in 2016. While employment declined in January, due to part-time job losses. This is the first drop in nearly a year and a half. The consensus estimate for 2018 is for moderate growth of 2.1%. Inflation appears to be under control and another rate hike in March from the Bank of Canada seems unlikely at this point. However, further rate hikes are anticipated for later in the year given the continuing expansion and the bank's desire to normalize interest rates.

The strong performance of the resource sectors and manufacturing is attributable to the rise in the price of oil over the past year. Oil and gas companies have been encouraged to explore and produce. This, in turn, has led to rising demand for equipment that’s given a boost to machinery manufacturers. The graph below shows the relationship between the output of the resource and the machinery manufacturing sectors for Canada over the last 10 years.

The recovery in oil prices is evident in Canada’s exports as well. Energy exports were the key driver of the 5.3% growth in merchandise exports in 2017. Energy exports grew a remarkable 32.5% last year on a nominal basis, and 10% in volume terms. Excluding energy exports, merchandise exports grew by only 1% compared to 2016.

Meanwhile, inflation remains just below the Bank of Canada’s target of 2% (see graph). Given the bank raised the overnight lending rate in January to 1.25%, it is unlikely to raise rates again in March, unless wage growth accelerates significantly. If the Bank of Canada were to raise its key policy rate in March, the loonie could appreciate against other currencies, though it would depend on what is happening with interest rates in the other countries. More rate hikes are likely later this year provided the economy performs well.

What does it mean for entrepreneurs?

  1. Businesses serving the oil industry will continue to benefit from the pick-up in oil prices. They should consider seizing this opportunity to diversify into other sectors.
  2. Given recent rate hikes, some households are likely scaling back spending and directing disposable income to meet higher mortgage payments. Further rate hikes later in the year will exacerbate this trend and could hurt consumer-focused businesses.
  3. With the global economy growing strongly, now is a great time to look internationally for growth opportunities.
U.S. economy at a glance

The U.S. economy is in a sweet spot now. Interest rates will move higher this year, but will they move up just enough to dampen inflation without sparking a recession?

The U.S. economy has performed well over the past year and this is expected to continue in 2018. Real GDP growth in the fourth quarter slowed compared to the previous two quarters to an annualized pace of 2.6%. Overall for 2017, the U.S. is estimated to have grown 2.3%, well above 2016’s 1.5%. Consumer spending was the main driver of economic growth last year. In the fourth quarter, strong demand for consumer goods caused imports to grow at their fastest pace in more than seven years. This strong growth in imports was due in part to a stronger U.S. dollar vis-à-vis many of the U.S.’s trading partners, making imports cheaper for Americans. Higher imports as well as a drop in business inventories were the key reasons for the slower fourth-quarter expansion.

The expansion is expected to continue in 2018

The recent federal tax reform, which cut the corporate tax rate among other measures, is likely to further stimulate the economy and as such the consensus estimate for U.S. growth this year is 2.7%. The key risk for the economy is that it overheats and interest rates move up more quickly than anticipated. A strong U.S. economy is positive for Canadian exporters, and higher U.S. interest rates will likely mean a lower loonie, further enhancing exporters’ competitive position. However, the good times could be short-lived if sizeable successive rate hikes slow the U.S. economy.

Status quo for U.S. policy rate and Janet Yellen’s last meeting

With the economy continuing to grow moderately, the Federal Reserve held its key policy rate at 1.5% on January 31. However, with the labour market appearing to tighten in January, inflationary pressure may be building. The economy created 200,000 net new jobs last month and wage growth hit an annual pace of 2.9%—the highest since June 2009. If this trend continues, it will set the stage for a rate hike in March when Jerome (Jay) Powell takes over from Janet Yellen as Chair of the Federal Open Market Committee (FOMC).

What does it mean for entrepreneurs?

  1. The U.S. economy is doing well and Canadian exporters should benefit from the strong growth south of the border. Entrepreneurs can take advantage of strong consumer demand by increasing their market share in the U.S.
  2. With U.S. rate hikes likely on the way in March, a differential with Canada’s interest rates should put downward pressure on the loonie, making Canada’s exports more competitive.
  3. Keep an eye on interest rates as successive rate hikes will raise borrowing costs for businesses and households which could reduce investment and spending thus dampening growth.
Oil market update—February 2018

Oil prices continued to rise in January as global crude oil supply remained in deficit. OPEC’s strong compliance with its supply cuts and higher refining activity, especially in the U.S., China and India, drew down oil stocks.

Globally, crude oil balances have been in deficit since the second quarter of 2017, around the same time that prices began to stabilize and turn upward (see graph). Over the past month, Brent crude oil has traded on average at US$69 a barrel, and West Texas Intermediate (WTI) has averaged US$63 a barrel. The drop in crude oil stocks is due to higher refining activity and declining production by the OPEC and other oil-producing countries.

The upturn in prices is largely driven by record refining activity…

Global refining activity attained a record in the fourth quarter of 2017, as U.S. refineries returned to full capacity post-hurricanes, refineries in China reached new heights, and India’s refineries hit capacity utilization maximums.

… and OPEC’s cuts

The extraordinary compliance by OPEC and fellow oil-producing nations to cut 1.8 million barrels a day has been crucial to the continued strength in the oil price recovery. Throughout 2017, compliance averaged 95%. In December countries cut more than 1.8 million b/d, according to the International Energy Agency (IEA). Unplanned production shortfalls in Venezuela are responsible for this lower output.

… with the sorry state of Venezuela taking center stage

Venezuela’s economy has been in free fall since 2014 and has shrunk by close to a third. Economic mismanagement and now U.S. sanctions are the main causes for the drop in oil production, which is responsible for nearly all of the country’s exports (and thus the key source for US dollars into the country) and half of the government’s revenues.

At its height, in the late 1990s, Venezuela produced 3 million barrels of oil per day (mb/d). Last December, the country produced half that amount. Venezuela’s main export is heavy crude oil, similar to Canada’s oil sands production. Venezuela’s weak production may decline further, supporting OPEC’s cuts and allowing other players to capture more market share.

To date, OPEC’s cuts have been sufficient to offset recent increases in supply in the U.S., Canada and other non-OPEC producers, but it is unlikely to continue

Higher prices are expected to continue to drive production higher this year, especially in the U.S., Canada and Brazil. The IEA anticipates supply to rise by 1.7 million b/d in 2018. That is 1 million b/d higher growth than in 2017. The U.S. will be responsible for the vast majority of that increase in supply. Already as of the end of January, the U.S. hit 10.2 million b/d and the U.S. Energy Information Administration (EIA) anticipates the U.S. will average 10.6 million b/d in 2018.

Will demand keep pace with supply?

Global oil demand is expected to remain relatively strong, increasing by 1.3 million b/d in 2018, according the IEA’s forecasts, with the United States to be a key driver of demand as its economy continues to expand. However, there are risks to this positive demand outlook. More middle-income countries are shifting away from oil towards natural gas for power generation as well as residential use. In Iran, Iraq, Pakistan, Egypt and Indonesia, between 2014 and 2017, oil demand declined by 500,000 barrels/day. China’s oil demand is expected to slow as its economy transitions more towards services away from goods production.

Higher prices will dampen demand, according to the IEA. The Agency estimates that a 10% increase in the price of Brent crude oil lowers demand by about 200,000 barrels a day. Already there has been a slowdown in demand growth in Europe attributed to price increases.

Bottom line

Oil prices have risen as the supply overhang has diminished. The ramp up in production, especially in the U.S., will put downward pressure on prices. Given the competing interests of OPEC and the other oil-producing nations, compliance with the supply cut agreement is unlikely to continue indefinitely. Furthermore, slower demand growth means that prices are likely to soften.

Other economic indicators

Bank of Canada could hold its key interest rate at 1.25% at its March meeting

After raising the overnight rate by 25 basis points to 1.25% on January 17, 2018, the Bank of Canada is likely to hold steady in March, unless wages and inflation surprise to the upside. The latest data show core inflation remains just below 2%, which is the mid-point of the Bank’s target range for inflation.

The loonie’s appreciation continued in January

The Canadian dollar closed at US$0.8135 at the end of January up from US$0.7971 at the end of December. The loonie appreciated against the US dollar in January, averaging US$0.81 for the month, as the Bank of Canada raised its overnight rate while the U.S. Federal Reserve kept its key rate on hold. Despite an appreciation, Canadian exporters still benefit from the cheaper loonie to trade with our southern neighbour. Interest rate hikes in the U.S. are expected in March and will put downward pressure on the loonie.

SME confidence is off to a good start in 2018

The Canadian Federation of Independent Business's Business Barometer Index rose by a solid three points in January, reaching 62.7, the highest since May 2017. The Index has clearly been following an upward trend since September. Small business executives’ confidence is on a roll across the country except in Prince-Edward-Island and Alberta where it took a dip last month. The recent rise in crude oil prices has helped oil-rich provinces gain confidence in the space of a year. Confidence in Newfoundland rose by almost six points during 2017 and in Alberta it doubled by that amount. Optimism in Quebec continues to outshine every other province. Nationwide, confidence in the professional services sector rebounded by 8 points in January, after falling in December, and it is now in second place, behind finance and real estate.

Credit conditions remain relatively stable for small businesses

Overall business credit conditions eased in the last months of 2017 according to the Bank of Canada’s Senior Loan Officer Survey. While non-price conditions were mostly unchanged, lower spreads were available to corporate borrowers as financial institutions competed for business. However, for small business borrowers lending conditions were unchanged.

Key indicators–Canada