An Interview with Dr. Warren Jestin, Senior Vice-President & Chief Economist, Scotiabank
There are wide-spread changes occurring in the world today: strife in the Middle East; financial instability in Europe; major concerns with the U.S. budget and debt, just to name a few. Dr.Warren Jestin, Senior Vice-President and Chief Economist of the Scotiabank Group, has kindly agreed to chat with us about the economic circumstances in Canada, and in the world context.
MI: Dr. Jestin, how would you describe Canada’s performance over the last two years compared to some of our major trading partners, whether it’s the United States or Europe or elsewhere?
Dr. Jestin: Comparing ourselves to the U.S. and other G7 nations, we’ve done very well. Canada’s banking system is the strongest in the world, weathering the financial crisis better than its counterparts in most countries. Our housing market has remained robust, with home prices in many Canadian markets near record levels at a time when average prices in major U.S. urban centres are 25% below their previous highs. We have record employment in Canada; whereas the U.S. is still down 7,000,000 jobs from prerecession levels. The U.S. had a domestic recession, deeply embedded in the household sector. We didn’t. Ours was an export recession reflecting weakness in our major markets – particularly the U.S. – and the rise in our currency above parity against the greenback. Looking ahead, we have a good chance of winning the G7 growth sweepstakes over the next half decade. However, given the growth challenges in the U.S., Europe and Japan, this won’t be a hard race to win.
Even with a smooth transition from recession to recovery and renewed expansion, Canada, the U.S., Europe and Japan are likely to have a slower economic performance on average than we’ve seen in previous decades. Unwinding outsized fiscal deficits and returning debt burdens back towards pre-recession levels will be a lengthy and painful process. Populations in G7 nations are getting older and, in many cases, workforces will be shrinking. There’s going to be enormous cost-related pressures on health care and social security associated with an aging, retired population.
Using a G7 benchmark also fails to capture the profound structural changes occurring in the global economic landscape. Emerging nations now account for about three-quarters of global growth and this share is bound to rise over the next decade. The world is becoming less U.S. and Euro-centric and our nation must adjust to this reality. There is a world of opportunities available to Canadian business, but they are different opportunities than existed a decade ago. Businesses that adjust to this changing economic landscape have the potential to prosper, but those that stick with strategies that worked a decade ago, avoiding unfamiliar markets, may not thrive and perhaps not even survive.
MI: Well, there’s a lot of issues about the United States, which is our principal trading partner, as far as I know at the present time. The U.S. itself is having a number of issues relating to its budget, its deficit and as you said, the housing market. Do you think that we can persist as a relatively strong economy if our largest trading partner is in fact suffering some severe issues in terms of the decline of the dollar and their own inability to seemingly reconcile how they’re going to run their own economy?
Dr. Jestin: Canada is betwixt and between the U.S. economy and the emerging world in terms of what drives our economy. Less than a decade ago, as much as 84% of our exports went south of the border. Now the percentage is in the low- to mid-70’s. Ten years from now, the U.S. will still be our principal trading partner, but its share of our exports will continue to drop. Cross-border travel reflects a similar shift — fewer Americans have been travelling to Canada each year for over a decade now. At the same time, our links to emerging nations are growing, primarily through resource exports. Robust growth in many emerging markets has translated into buoyant demand for oil, copper, nickel, zinc, iron ore, coal, potash, wheat and a variety of other commodities. We expect growth in income and domestic demand to remain very strong in China, India and a number of other Asian and Latin American nations, and for that reason, are optimistic about the outlook for Canadian exports, particularly in the resource sector.
Within Canada, the changing global landscape suggests that the resource-rich western provinces as well as Newfoundland and Labrador will lead Canadian growth. At the same time, provinces such as Ontario – more dependent on the U.S. and US-focussed manufacturing – will lag as their economies adjust to new global economic realities. I’m optimistic regarding Canada’s growth prospects over the next decade, but this optimism is based on the inherent strength of our resource sector and my belief that our manufacturers and service providers will be able to shift their focus away from slower-growth markets to ones where expansion opportunities are much greater.
MI: Your point about the strategies in the past not necessarily being the strategies of the future, I’m thinking back and I’m sure you recall the earlier policy emphasis on Canada becoming a technology powerhouse, a manufacturing powerhouse and competing sort of on a hemispheric if not on a western world scale. But what you’re saying seems to suggest and we look at Ontario for example that potential is diminishing and we are perhaps moving back into the hewers of wood and drawers of water which the critics would argue has been our history. Do you think that’s a fair comment?
Dr. Jestin: That’s an analogy that’s been around for a long time, and during the 1990s morphed into a ranking of industry growth potential based on whether firms were in the new or old economy. At the time, I wrote that this view was based on a false analogy that was not only highly misleading but, as a driver of government policy and spending, had the potential to be quite wasteful of our scarce public resources. As we learned in the late-1990s, high tech did not guarantee high growth. And firms in the so-called old economy such as mining and energy are often on the leading edge of technology. Witness the recent ability to tap into shale gas deposits through fracking and horizontal drilling. Drilling thousands of feet into the ground, turning the drill hole at a 90 degree angle and releasing previously tapped energy resources in shale deposits is not only mind-boggling, but it has been a game changer for the petroleum sector and has altered the relative competitiveness of sources of energy for power generation.
MI: What I hear you saying is in fact, if I can interpret it, is that there’s an opportunity for Canada to utilize its technological expertise to optimize its resource development capability.
Dr. Jestin: Absolutely and the potential for technological innovation and entrepreneurial spirit to provide a competitive edge for Canadian industry extends throughout our economy. But our governments must avoid industrial policies that attempt to pick winners and losers, because the history of such well-meaning policies is fraught with failure. It is hard enough for businesses to sort out winning and losing strategies in a global marketplace that is changing rapidly. The best public policy — and for the most part the policy of our current government – is to establish a competitive tax environment and work towards levelling the playing field, thereby allowing businesses to prosper according to their own competitive abilities and strategies. This tax structure must be built on a foundation of sound fiscal balance, which has become a strategically important national competitive advantage over the past decade. Our governments also have to give high priority to nurturing and sustaining a globally competitive transportation and communications infrastructure.
Of all the challenges confronting our governments, one of the biggest will be to ensure that Canada has a truly world-class workforce. We will never win the competitive race in terms of rock bottom labour and production costs, particularly with our currency above parity with the US dollar and likely to stay there. We must compete on the basis of value added, our labour force skills, managerial ingenuity and entrepreneurship. Successful firms will have these traits and be highly adaptable to rapidly changing market circumstances. They will compete on the basis of service excellence, often in niche markets plugged into much larger global supply chains. With a winning competitive environment, sound property rights, rule of law, and a good quality of life, there will be a world of opportunity for Canadian businesses in the decade ahead.
In many ways, our government policies are pointed in the right direction. The same cannot be said about the current direction of U.S. government policy. Washington is facing a deficit this year in the $1½ trillion dollar range – roughly 10% of GDP. With few initiatives underway to meaningfully close the gap, their big deficit problem is turning rapidly into an even bigger debt problem. On the horizon, U.S. governments will be confronted with escalating health care and social security costs, with rising interest rates adding to a soaring debt service burden. Ultimately, big spending cuts and tax increases will be required to restore a more balanced fiscal posture. Delaying action will add substantially to the ultimate pain of adjustment, particularly if global investors become more reluctant to underwrite what have become chronic massive fiscal excesses.
MI: There’s obvious concern being expressed about the value of the Canadian dollar. Our dollar is appreciating. Both the Russian and the Chinese central banks have said that they would prefer to invest more in Canadian dollars. Do you see our currency remaining strong in global markets?
Dr. Jestin: Yes, but recent history has also shown that our Loonie is prone to sudden bouts of strength and weakness. Over the past four years alone, our currency has been as low as $0.77(US) — at the height of the financial crisis — and as high as $1.09(US). Looking through the inevitable bouts of market volatility and occasional big spasms, I believe that the currency is likely to stay at or above parity, and may go even higher. The reason is that our economic and fiscal fundamentals are much better than those south of the border. We are a commodity-rich country in a commodity-short world. Our financial system is a world leader. Global investors are looking at these positives alongside our recent currency strength and investing here – not just in the mining and energy sectors, but in commercial and residential real estate. Canada offers asset diversification as an alternative to investors with heavily overweight U.S. dollar portfolios.
While these positive developments have tended to drive our currency higher for domestic reasons, more negative U.S. fundamentals have tended to erode the value of the greenback against a broad basket of global currencies. Over the next five years, I expect the US dollar, and probably the euro, to weaken against two groups of currencies — one being emerging market currencies and the other being commodity-based currencies. The Loonie is a commodity currency and so is the Australian dollar. In fact, the Aussie dollar is not only trading at a premium with respect to the US currency right now, it has been above the Canadian dollar for the first time in my life.
MI: Well now you make the point about attractiveness of our resource base and you also pointed out a couple of times in the conversation about some things that have happened recently that you hadn’t seen before in your lifetime. You and I are…I’m actually a little older than you…you and I can remember well, I think, the sort of the Canada first policies of the 1970’s and so forth and the issues around Canadian ownership. It may be wonderful to bring in the foreign currency and that’s perhaps a vote for, as you say, the base that we have here, the quality of regulation we have here, the financial stability. But they also bring their own culture and their management styles here. So we have the largest and longest strike in history in Sudbury. And there are other issues around how we do things in Canada from a regulatory perspective and as a cultural approach.
So is there a likelihood that we’re going to have a real push on our regulatory environment and on our own cultural values as a result of these kinds of investment opportunities seen from an international perspective?
Dr. Jestin: The change in global investment patterns will profoundly influence how we do business over the next decade. The financial resources and savings that have been built up in emerging countries are enormous. China currently has over US$3 trillion dollars in foreign exchange reserves; Russia and Saudi Arabia both have over US$460 billion; and a long list of nations including Brazil, Taiwan, Hong Kong and South Korea have hundreds of billions of official investable reserves. Looking ahead, managers of these large pools of liquid assets will likely shift some of their large holdings of U.S. government debt into other asset classes and some of it will involve direct ownership in areas such as infrastructure, mining, etc. Erecting barriers to protect domestic industries risks retaliation that could materially hurt trade and investment plans of Canadian businesses. What we need is a clear and consistent national investment policy plus well-articulated regulations that ensure all businesses operate on a level playing field, complying with Canada’s environmental laws and regulations.
MI: What about educating our own citizens as to what their requisites are to be able to participate in this world? For example, a foreign company comes in, makes an investment, follows the rules in general terms but does things because of their own cultural or management that really irritate and anger the local citizenry. I happened to go through this situation with a Canadian company in Greece and they torched the facilities and caused $1.8 million dollars’ damage and almost killed someone. The reciprocal could easily happen here where there isn’t a good fit. So what about educating our own citizenry?
Dr. Jestin: It’s a two-way street. We expect international businesses operating here to understand our business practices and culture, but Canadians investing abroad also must expect make similar adjustments. We have an important competitive advantage in this area based on a diverse population with deep linkages with a wide variety of nations. There are a host of small- and medium-sized businesses in B.C.’s lower mainland and in the Greater Toronto Area that have deep roots and successful business linkage in China, India and other emerging economic powerhouses. But there are still many businesses that are relatively unfamiliar with the world of opportunities beyond our shores and have no idea how to link their operations to this rapidly growing realm. This needs to change because Canada’s future economic prosperity hinges on becoming more comfortable in dealing with these markets.
MI: So based on what you’ve said, the outlook for Canada is, I think, pretty positive in terms of resource development, the diversity of our culture, the fact that we are a commodity-driven currency in a world running short of commodities. It’s a balanced set of commodities of mineral resources and food resources and so forth, and water use which is going to cause a controversy and we know that too. What could go wrong? How could we screw it up?
Dr. Jestin: I see an abundance of both opportunities and risks on the horizon. Looking at the risks, the one that particularly concerns me is the potential to revert to more protectionist beggar-thy-neighbour investment and trade policies in the U.S. or Europe. Another risk on the horizon is that income and wealth disparities will widen in many countries. Many businesses and workers will succeed in taking advantage of the opportunities offered by the changing global marketplace. Others will not be able to adjust to these new markets and skills requirements and will be confronted with considerable challenges. A widening gap between the successful and unsuccessful is fertile ground for social unrest.
This brings me back to a critical point I made earlier. Job one for all Canadian governments is to ensure that their policies are designed to build and sustain a globally competitive foundation that encourages business investment and job creation. As a country we already have enormous advantages, but we must make sure that a broad cross-section of Canadians understands that the world is changing rapidly and help to ensure that they have the skills required to participate successfully in this brave new world.
MI: Shall we leave it at that?
Dr. Jestin: We’ve covered a lot of ground.
MI: Thank you so much. You’ve been extremely generous.
Thanks to Brian Hay for conducting the interview on behalf of the Institute.
