Terms of Trade Effects in Canada’s Economy
Heather Scoffield had an interesting little “how-to” guide in Saturday’s Globe and Mail on the macroeconomic effects of the improvement in Canada’s terms of trade (the result of soaring global prices for the resources which Canada increasingly exports).
The terms of trade, for the blissfully uninitiated, is the ratio of a country’s export prices to its import prices.Â You can get richer (in global terms) simply if the things you make tend to become more valuable over time.Â (With resources, in general, this doesn’t happen for long.Â Long-term resource prices tend to fall — although who knows, perhaps the China factor combined with genuinely binding resource constraints may now be altering that historical truth.Â I’m not yet convinced.)
She cites Dept of Finance figures (from last week’s fiscal update) showing that the expansion of Canadians’ real income has been much quicker than the expansion of real output — simply because our output buys more (on world markets, anyway) than it used to.
I accept that the resource boom is one of the reasons there does seem to be an awful lot of money flying around Canada’s economy these days (including, most obviously, in federal coffers).Â But I do not think I believe that terms of trade effects per se can be the reason why.Â Let’s think this through.
Imports are relatively cheaper, compared to exports.Â But this is a price level effect, not an income-generating effect.Â To experience this, import prices must fall.Â As we all know, this hasn’t really been happening at the consumer level.Â In the first place, most of what we buy (private services, public services, construction, and a share of manufactures) is still non-tradeable.Â Secondly, retailers haven’t been passing through their savings.Â They’ve been pocketing them — generating bigger profits.
Even at the aggregate level, I am skeptical of the notion that import prices have fallen.Â After all, the rise in the loonie is only offsetting, in some ways, the run-up in globally traded commodity prices (which is itself caused, in part, by the fall of the U.S. dollar — especially for greenback-denominated commodities like oil).Â And to calculate its indices of import prices, I have a sneaking suspicion that StatsCan just deflates global prices by the exchange rate — in which case the decline in import prices is a definitional phenomenon, not a measurable phenomenon.Â (Paul T, are you out there?Â Please shed light on this methodological issue if you can.)
Terms of trade improvement cannot explain growth in nominal incomes.Â They can explain how you might spend that nominal income more aggressively (especially on imports, foreign travel, foreign acquisitions, etc.).Â And that spending itself, I would not deny, could have indirect macroeconomic benefits (demand-led expansion).
The real growth in nominal incomes I suspect is occurring for more direct reasons: resource industries in particular, and business in general, are super-profitable these days.Â Some of that profit generates new spending at various levels of the economy, and new revenues for government (a shift in national income from workers to businesses actually increases government revenue, because average effective corporate income tax rates are still higher than average effective personal income tax rates).
Real output growth has not been spectacular at all in Canada (and was slower in the last quarter than the U.S., believe it or not, yet they’re cutting interest rates and we’re probably raising them).Â There’s a lot of spending going on in Canada.Â How long it will last is questionable.Â And I think it has very little to do with terms of trade.
These are tentative thoughts.Â Any other ideas on this subject out there?