Falling off the ‘fiscal cliff’ will hurt Canada too

by Eugene Lang. Posted October 26, 2012


It has been said that when the U.S. sneezes Canada catches a cold.  Today, America’s economy has a low grade fever that could develop into pneumonia in the next few months.  This takes the economic form of relatively slow post-recession growth by US historical standards—an annualized rate of 2.0% according to the US Department of Commerce’s most recent estimate.  The looming pneumonia is another American recession, a very real possibility.

The path the illness takes is dependent in the immediate term on whether Washington avoids the so-called “fiscal cliff”.  If the politicians fail to avoid driving off this cliff, the American economy will suffer a major blow and will in all likelihood fall back into recession.  This would be very bad news for Canada’s economy.

At the end of this year, the tax cuts put in place by President Obama’s predecessor, George W. Bush, which has been considered important stimuli during and after the recession, will expire. This will take purchasing power out of the hands of the debt laden American consumer.  At the same time a “sequester,” part of the 2011 Budget Control Act, indiscriminately cuts $1.2 trillion over nine years from spending in Washington.  According to the Congressional Budget Office, the combined effects of these two measures equal about 3.6% of GDP in 2013.  Other analysts say it could be more like 5% of GDP, either of which is enough to end the fragile US recovery and tip the economy back into recession.

To avoid falling off the fiscal cliff the newly elected Congress and the Administration would have to agree before the end of the year on a budget that reduced Washington’s deficit by an amount at least equivalent to the sequester.  In theory this is very easy.  As TD CEO Ed Clark recently said, “If you put five economists in a room and say you each have half an hour to come up with a solution for the United States (fiscal problem), all five could say, ‘I don’t need half an hour.’”  In practice, however, it seems an almost impossible task in the ideologically divided Washington of today, which reflects the deep divides within American society itself on the role and size of government—what The Economist calls “The 50-50 nation”.

What does all this mean for Canada?  We are a trading nation.  One third of our GDP, and one in five jobs in Canada, is export dependent.  While Canadian exports to the US have declined in recent years – from a peak of over 80% of Canada’s total exports a decade ago—the US is still far and away our biggest market, accounting for nearly 74% of Canada’s exports in 2011.  By contrast, Mexico, our other NAFTA partner, accounted for a paltry 1.2% of Canada’s exports last year, the UK 4.2% and China 3.8%.

Hence, if the US tips back into recession as a result of falling off the fiscal cliff, the negative economic effects in Canada will be real and significant, slowing what is already relatively slow growth in this country.

We also know that when the US economy struggles, protectionism south of the border rises.  This came home to Canadians in spades during the 2008-09 recession with the Buy American provisions of the American Recovery and Investment Act of 2009, which excluded Canadian firms from supplying projects funded under Washington’s stimulus measures.  Further protectionist measures emanating from Washington and negatively affecting Canada’s exports could rear their ugly heads if there is a second US recession in five years, in a country with a persistently high, and historically anomalous unemployment rate—nearly a percentage higher than that of Canada.

Put simply then, averting the fiscal cliff in Washington really matters in this country, as Canada’s Ambassador to Washington Gary Doer made clear Wednesday in a speech in Vancouver.  So let’s hope our friends to the south can get beyond their 50-50 divide in the next sixty days and come to agreement on a new fiscal plan that will avoid plunging their economy into another recession and doing significant economic damage to their neighbour.