BUDGET AND FISCAL PLAN — 2002/03 to 2004/05
|
|||
|
|
|
|
|
BUDGET AND FISCAL PLAN — 2002/03 to 2004/05 |
|||
 |
||
|
||
|
Chapter 2: BRITISH COLUMBIA ECONOMIC REVIEW AND OUTLOOK |
||
The U.S. economy is expected to recover in 2002 and Canada is assumed to follow, although there are still questions about the strength of the North American near-term recovery. In 2003 and beyond, the U.S. and Canadian economies are forecast to lead global economic growth.
Based on these and other external growth assumptions of the province's major trading partners, the most likely outcome for the British Columbia economy is to grow 0.6 per cent in 2002 then pick up to 2.8 per cent in 2003. The average forecast of the British Columbia Economic Forecast Council was slightly higher, expecting growth of 0.7 per cent in 2002 and 3.0 per cent in 2003 (see topic box). In 2004 through 2006, the British Columbia economy is expected to grow about 3.0 per cent per year reflecting stronger economic growth in the province's trading partners, higher commodity prices and stronger consumer and business sectors. Over the medium-term, investment in the province is forecast to increase as tax cuts contribute to improved business confidence and opportunities.
As with all forecasts, the economic outlook presented here has risks attached to it, both on the upside and downside. These risks may affect the near-term, the medium-term, or both. Some of these risks include the global recovery, the war on terrorism and financial crises in Japan and Argentina. Given these risks, a number of possible paths exist for the North American and world economies, and these suggest a range of possibilities for the British Columbia economy as well.
The Ministry of Finance budget forecast is the most likely outcome based on current knowledge and judgement, and a consistent set of assumptions about how the global economy will evolve. An assessment of the forecast risks needs to take account of the range of possibilities.
To illustrate the possibilities surrounding the budget forecast, two other economic scenarios are presented, one that assumes slower growth, and the other based on a quick rebound in the North American economy. Although events will inevitably vary somewhat, the budget outlook reflects the most likely forecast.
During the last six months of 2001, global growth estimates for 2001 and forecasts for 2002 were continually revised downward. The Organization for Economic Cooperation and Development recently reported that the global economy slipped into its first recession in 20 years, with output shrinking in the last two quarters of 2001 and likely remaining weak in the first half of 2002. While an upswing in the global economy is not expected until 2003, the U.S. economy is expected to recover in 2002.
The National Bureau of Economic Research estimated that the U.S. economy entered a recession in March 2001. The U.S. economy (British Columbia's largest trading partner) contracted at a 1.3 per cent annual rate in the third quarter. Preliminary results indicate that the U.S. economy grew at a 0.2 per cent annual rate in the fourth quarter, with consumer and government spending contributing to growth, and partly offsetting a drawdown of inventories.
The U.S. recession in 2001 was largely due to a decline in business investment. There was considerable slack in the manufacturing sector as unused production capacity reached historical highs. However, the consumer sector continued to spend, aided in part by deep discounting by motor vehicle dealers and low mortgage rates which supported the housing sector. This effectively moved forward some consumer spending so that coming out of the recession, the economy may not have the typical amount of pent-up consumer demand to help drive economic growth. This should result in a slower economic recovery this year.
While low interest rates boosted consumer spending, fiscal policy was also aimed at improving the U.S. economy. The U.S. government reduced taxes by $70 billion, effective January 1, 2002, to help the economy over the medium-term.
The Canadian economy (British Columbia's second largest trading partner) followed the U.S. economy into the slowdown, although the data suggests the downturn in Canada could be shorter, and not as deep. Consumer and business confidence in Canada was not impacted by the events of September 11th to the same extent as in the U.S. Canadian real GDP contracted at a 0.8 per cent annual rate in the third quarter. While fourth quarter data will not be available until February 28th, retail sales and housing data indicate growth is expected to be in line with the final quarter in the U.S. Retail sales and housing starts were strong through the end of 2001, although incentive-driven motor vehicle sales inflated November's retail sales data.
Overseas, Japan continues to struggle with chronic structural problems in its financial sector, and combined with the U.S.-led global slowdown, the economy entered its fourth recession in a decade. Real GDP in Japan contracted at a 2.2 per cent annual rate in the third quarter. In 2001, the economy shrank an estimated 0.4 per cent. The share of British Columbia's merchandise trade with Japan has fallen during the past decade as the Japanese economy has floundered. In 2000, 14.3 per cent of British Columbia's goods exports were destined for Japan, compared with 27.8 per cent ten years earlier.
The German economy, Europe's traditional growth engine, grew only 0.6 per cent in 2001 as the global slowdown hurt exports and hampered investment. The economy stalled in mid-2001 and continued to slow for the rest of the year, aggravated by the fallout from the September 11th attacks in the U.S. Retail sales and the key business leading indicator were up strongly in November.
Outlook: As evidence of the U.S. slowdown in 2001 emerged, forecasters revised down their outlook for the world's largest economy in 2002 (see Chart 2.1), tumbling from 3.5 per cent in January to 0.7 per cent in November. The consensus growth forecast has now stabilized at 0.9 per cent.
|
A turnaround in the U.S. is expected to lead a global recovery in 2002. The U.S. Federal Reserve has cut interest rates dramatically and the U.S. government has adopted fiscal policies that should stimulate the economy. Real GDP is expected to grow 0.9 per cent in 2002 then 3.3 per cent in 2003. (See Chart 2.2.) Over the medium-term, economic growth in the United States is assumed to average 3.0 per cent per year. This is close to current estimates of potential output growth (the change in the level of output that the economy generates when people and capital equipment are fully-utilized).
Between 1995 and 2000, the U.S. economy posted annual growth rates in excess of 4.0 per cent, stronger than the annual rates recorded in the 1970's and 1980's. This stronger growth was believed to be due to increased productivity in the U.S. economy that allowed it to grow faster without running into bottlenecks in production and rising prices.
However, with the recession in 2001 prompting closer examination of this issue, new research suggests the U.S. economy may not have undergone as profound a "productivity miracle" as previously believed, and potential economic growth is expected to return to around 3.0 per cent.
|
The Canadian economy is expected to grow 1.0 per cent in 2002, then pick up to 3.3 per cent in 2003. Employment is a lagging indicator of economic activity and as such, is expected to decline in the first part of 2002 then increase in the second half of the year. Over the medium-term, economic growth is assumed to mirror the performance of the U.S., growing in line with the Bank of Canada's estimates of potential growth.
Japan's economy is expected to contract 1.0 per cent in 2002 following a decline in 2001. Japan's economic outlook hinges on government reforms since its key short-term interest rate is already near zero. With significant financial reforms needed, and still three to five years away, growth prospects over the forecast period are weak.
The outlook for Europe depends on the U.S. as one-fifth of its exports are destined for the U.S. The European Central Bank also cut interest rates in 2001 but not to the same extent as other central banks. As a result, interest rates are relatively high and are expected to be less of a boost to growth.
Since easing by the central banks began in early 2001, the U.S. Federal Reserve cut short-term interests rates 11 times in an effort to add liquidity and maintain spending. Similarly, the Bank of Canada lowered short-term interest rates nine times in 2001, lowering the key overnight interest rate from 5.5 per cent in January to 2.25 per cent in December.
Although the Canadian dollar started 2001 near 67 cents U.S., it traded between 62.5 and 64 cents for most of the second half of the year, reflecting falling commodity prices. At the beginning of 2002, the Canadian dollar fell against its U.S. counterpart, as the U.S. dollar strengthened against most currencies. The falling Canadian dollar did not reflect economic developments in Canada but rather a flight to quality by international investors. In times of uncertainty, the U.S. is often viewed as a safe haven for financial investments.
Outlook: The forecast includes the Bank of Canada's January 15th 25 basis point cut in the target overnight rate. North American short-term interest rates are expected to rise gradually in 2002. As a result, inflation pressures are expected to remain in line with the established inflation target of two per cent over the medium term in Canada, and at an acceptable level in the U.S. As economic growth picks up in 2003, the forecast assumes more frequent increases in short-term interest rates to ensure inflation remains under control. By the end of the forecast period, short-term interest rates are expected to be in the range of 4.5 to 5.0 per cent, but still below their 2000 level (see Chart 2.3).
Rising commodity prices should support a gradual rise in the Canadian dollar. The British Columbia Ministry of Finance expects the Canadian dollar to appreciate from 63.5 cents U.S. in 2002 to 67.5 cents U.S. in 2006.
Prices of most natural resource commodities fell in 2001 reflecting the global industrial slowdown. Metal and mineral prices fell steadily through the year. Lumber prices started low then rose during the spring and early summer on stronger-than-expected U.S. housing, but have fallen off since.
The Ministry of Finance Export Commodity Price Index, a weighted average of key commodity prices, fell 2.2 per cent in 2001. Chart 2.4 shows the effect on the index of the natural gas price spike in December 2000 and the lumber price peak in July 1999. The lower commodity prices combined with lower export volumes to reduce the value of the province's exports. As a result, trade contributed less to overall economic growth in 2001 than in 2000.
The Canada-U.S. softwood lumber agreement governing softwood lumber exports to the U.S. expired on March 31, 2001. On August 9th, the U.S. imposed a 19.3 per cent preliminary countervailing duty (CVD) on softwood lumber shipments from Canada, and in October 2001 added a preliminary anti-dumping duty of close to 13 per cent. The provisional nature of the CVD on exports to the U.S. meant that it could only be in effect for 120 days. At the time of writing, British Columbia softwood lumber exporters were continuing to post bonds to cover the anti-dumping duty, but CVD bonding or cash deposits were not required for entries made between December 15, 2001 and mid-May 2002. If talks between Canada and the U.S. do not reach an agreement, the Department of Commerce will rule on the final value for these two duties on March 21st. Canada has instigated a World Trade Organization challenge of the CVD preliminary determination and a panel was appointed this month.
The general impact of a duty is to raise the cost to Canadian producers, and as a result reduce Canadian producers' ability to compete in the U.S. market, forcing higher-cost sawmills to close. In the longer term, the tariff reduces the profitability of Canadian sawmills relative to U.S. mills and leads to proportionately less investment in the sector and a decrease in relative competitiveness.
U.S.-Canada discussions have been taking place over the last few months to determine whether possible policy changes could lead to a durable resolution of the softwood lumber trade dispute. The B.C. government has been engaged in these talks, along with the federal and other provincial governments. In December, the governments of British Columbia, Alberta, Ontario and Quebec tabled written proposals for policy changes. B.C.'s proposal includes changes to stumpage, forest tenure and regulatory requirements. In early February, talks were on hold while Canada awaited a counter-proposal from the U.S. side. Talks were scheduled to resume the third week of February.
The forecast assumes that whatever the outcome of the softwood lumber dispute, the forest industry will be under continued pressure to reduce costs in order to remain competitive. This will result in a major restructuring of the British Columbia forest industry, particularly on the coast. Initially there will be a decline in capital employed in the forest industry as less productive sawmills close and some consolidation occurs. Further into the forecast period, investment should increase as companies make capital investments to achieve higher productivity.
Outlook: The average price of British Columbia goods and services exports is expected to fall 0.6 per cent in 2002 then rise 2.9 per cent in 2003. The increase should be broad-based, with most commodity prices rising moderately. Benchmark spruce-pine-fir prices are expected to rise to $275 U.S. per thousand board feet in 2003 and remain at that level through the forecast period (see Table 2.8.5). Pulp and newsprint prices are expected to increase as demand for those products picks up. Natural gas prices are expected to be below 2001's average due to price spikes early last year that are not expected to be repeated in 2002. Over the forecast period, natural gas prices are assumed to remain higher than their historical average, reflecting an increase in industrial demand.
The British Columbia economy is expected to begin a recovery in mid 2002. As growth in the province's key trading partners picks up in 2003, so should growth in British Columbia. Between 2004 and 2006, the economy is forecast to grow just over 3.0 per cent annually.
The British Columbia economy trades goods and services in a competitive world market. The U.S. is the province's most important trading partner with almost two-thirds of British Columbia merchandise exports going south of the Canadian border. The province's domestic sector is relatively smaller than that of the U.S. or Canada and as such, trade developments including growth in the province's trading partners or commodity price changes, have a greater impact on British Columbia.
British Columbia exports started 2001 at record high levels, due to a spike in energy exports, then fell during the rest of the year. As a result, exports were down 1.0 per cent year-to-date through November, but were 22.8 per cent below last November's levels (see Chart 2.7). Excluding energy products, provincial exports were down 15.4 per cent in November, led by a decline in the value of forestry-related goods.
Outlook: Exports of wood products continue to be hurt by the preliminary countervailing and anti-dumping duties levied on softwood lumber. The reduced activity in the lumber sector, weak global industrial demand and falling demand for energy products could lead to reduced international exports in 2002. In 2003, as the U.S. and global economies turn around, increased demand and firmer prices should boost goods exports. Service exports are forecast to improve in 2003 alongside stronger U.S. and Canadian economic growth.
Total employment fell 0.3 per cent for 2001. Employment peaked in March 2001 and declined steadily through the last half of the year. In addition to the overall decline in the number of jobs, there was a shift from full-time to part-time employment and a reduction in hours worked, developments typically seen in an economic slowdown. Chart 2.8 shows employment ended the year 3.1 per cent below its December 2000 level.
The unemployment rate averaged 7.7 per cent in 2001, ending the year at 9.7 per cent.
Outlook: Total employment is expected to decline 0.2 per cent for 2002, as the economy works to replace the jobs lost in 2001. Employment is expected to rise during 2002, but the low level at the beginning of the year results in the annual average being lower than in 2001. The unemployment rate is expected to average 8.7 per cent in 2002, improving to 8.3 per cent in 2003.
Over the medium-term, employment growth is expected to pick up, adding an average of 45,000 jobs per year through 2006, to total 2.1 million in 2006. Growth of the province's labour force is forecast to pick up in 2005 and 2006 reflecting increased interprovincial migration. However, employment growth exceeds labour force growth and, as a result, the unemployment rate improves to 7.2 per cent in 2006.
Consumer Spending and Housing: Consumer spending accounts for about two-thirds of the provincial economy. British Columbia consumers, like their Canadian and U.S. counterparts, continued to spend during the economic slowdown. The value of provincial retail sales remained well above year earlier levels through to November (see Chart 2.9), helped by a surge in new motor vehicle sales in the final few months of the year due to low interest rates and deep discounting of new motor vehicle prices. In addition, a robust housing sector boosted sales of furniture and appliances in the first three quarters of the year.
Lower mortgage rates helped the recovery in the housing market in 2001. Housing starts were up 19.5 per cent. Existing home sales were up 28.2 per cent in 2001 and existing house prices stabilized.
Outlook: Consumer confidence and spending is expected to be affected somewhat by the declining employment in the second half of last year. This could be partly offset by low consumer interest rates and signs of recovery in the first quarter of 2002. After adjusting for inflation, consumption of goods and services is expected to increase 1.9 per cent in 2002 and 3.2 per cent in 2003.
Over the medium-term, spending on goods and services is forecast to average about 2.6 per cent a year.
Housing starts are forecast to total 18,200 units in 2002 and 19,750 units in 2003 as the lagged effect of low interest rates continues to support demand for housing. The level of residential construction is expected to reflect stronger population growth in 2004 to 2006, with housing starts reaching around 24,000 units in 2006.
Business and Government Activity: The North American recession was accompanied by reduced business investment. In British Columbia, corporate profits and investment were further reduced by developments in the province's forest sector. Business investment in machinery and equipment, non-residential structures and inventories accounts for just over ten per cent of economic activity. The government sector accounts for between ten and fifteen per cent. While total building permits were up 11.8 per cent in 2001, non-residential building permits trended downward in the fourth quarter.
Outlook: With an uncertain outlook for the forest sector in the near term, corporate pre-tax profits are expected to decline 7.5 per cent in 2002 before turning around to post growth of 7.5 per cent in 2003. Inflation-adjusted investment in fixed capital is expected to increase 2.3 per cent in 2002 and 4.6 per cent in 2003. Real investment is forecast to average about 5 per cent per year through 2006, reflecting the impact of lower corporate income tax rates and the tax exemption provided for production machinery and equipment, in addition to an improved business outlook. Over the medium-term, business investment in machinery and equipment is expected to increase alongside growth in corporate profits. Non-residential construction investment is also forecast to improve during the next five years.
Inflation-adjusted expenditures for all levels of government (including federal, provincial and local governments) are forecast to decline 1.4 per cent in 2002 and 3.4 per cent in 2003. The provincial government accounts for about one-half of current government spending, with the federal government making up the second largest share at just under 40 per cent. Over the medium-term, total government expenditures are expected to continue to decline, mainly reflecting the provincial government's announced spending reductions.
Inflation: Inflation, the rate of change in consumer prices, averaged 1.7 per cent in 2001. The change was due to higher prices for food, health and personal care, alcohol and tobacco as well as heating oil and natural gas in 2001. Electricity prices were lower in 2001, largely due to one-time rebates by BC Hydro.
Outlook: Inflation is expected to remain modest, averaging 1.4 per cent in 2002 and 1.7 per cent in 2003. As demand picks up, prices are forecast to rise by 2.0 per cent in 2005 and 2006.
|
As with all forecasts, the economic outlook presented here has risks attached to it, both on the upside and the downside. These risks may affect the near-term, the medium-term, or both. While geopolitical events have evolved positively since the fall of 2001, and consumer confidence has improved, some risks remain. These include the global recovery, the war on terrorism and financial crises in Japan and Argentina. The most important risk to the British Columbia economic outlook is the timing and strength of the U.S. economic recovery, which hinges on a turnaround in business investment.
The most opportunistic risks to the British Columbia economy are:
Alternatively, downside risks include:
Given these risks, a number of possible paths exist for the North American economies, both in the near-term and in the medium-term. To reflect this, two possible scenarios were developed with more optimistic and more conservative assumptions. These indicate a range of possibilities around the budget economic forecast.
The reality is that the future may not unfold exactly as set out in any of these scenarios. While by 2004/05, the budget forecast provides the most likely outcome, the scenarios provide a range of probable outcomes, with there being slightly more risk that things might improve as opposed to the risk that they might deteriorate further.
For the near-term, the U.S. economy may rebound quickly or continue with slow annual growth of 0.5 per cent or less in 2002. Similarly, numerous outcomes exist for the medium-term. After a quick rebound in 2002, the U.S. economy may continue to have the very strong increases in productivity, and hence real GDP growth, that characterized the late 1990s. This combination of a quick bounce back in 2002 and a strong medium-term productivity performance is referred to as the "rebound and recovery" scenario. This scenario relies on the current monetary and fiscal stimulus in North America to boost economic growth.
Or, after slow and hesitant growth in 2002, the U.S. economy may return to the weak productivity and output growth that characterized the 1970s and 1980s. This is referred to as the "slow recovery" scenario. In this scenario, high levels of consumer debt in the U.S. and the large U.S. current account deficit hold back growth. These different growth paths mean different levels of economic prosperity for British Columbia.
If the U.S. and Canadian economies follow the slow recovery scenario, British Columbia real GDP is expected to post almost no growth in 2002 and average 2.1 per cent annually in 2003 through 2006 (see Table 2.5). In this scenario, consumer spending is weak, reflecting job losses in 2002. The unemployment rate peaks at 9.1 per cent in 2002 then falls gradually over the medium-term as employment conditions improve. Residential and business investment grow slowly in the first two years. Commodity prices are flat then rise slowly, and combined with a gradual increase in global industrial activity, generate modest increases in British Columbia exports. Business investment is expected to increase 1.6 per cent in 2002 then picks up to average 3.6 per cent per year. Over the medium-term, the effect of tax cuts is muted somewhat by relatively weak consumer and business confidence.
On the other hand, if the U.S. and Canadian economies respond to the monetary and fiscal stimulus already in place with strong growth in 2002 and beyond (the rebound and recovery scenario), the British Columbia economy could grow 1.6 per cent in 2002 and average 3.7 per cent per year in 2003 through 2006 (see Table 2.6). In this environment, the British Columbia economy adds 245,000 new jobs, or about 11 per cent of total employment by 2006. Over the medium-term, residential and business machinery and equipment investment contribute to the faster pace of growth as tax cuts encourage investment.
These two scenarios provide a range around the budget forecast. Although events will inevitably vary somewhat, the budget outlook reflects the most likely forecast.
In any event, the two scenarios should not be taken to represent absolute upper and lower bounds to the forecast. Rather, they represent a reasonable range in which the actual outcome is likely to occur.
|
|
|
| Topic Box: | |
| The Economic Forecast Council, 2002 >> | |
|
|
|
|
|
|
| 1 | This report incorporates information available as of February 6, 2002. All annual and quarterly references are for the calendar year. |
|
BUDGET AND FISCAL PLAN — 2002/03 to 2004/05 |
|||
 |
|
|
 |
 |
|||
