The shape of the recovery

By Peter Drake | July 3, 2009 | Last updated on July 3, 2009
5 min read

There is enough evidence that the majority of the world’s economies are moving toward recovery that much of the discussion is now focusing on when we will actually move into recovery mode and what shape it will take.

We will be in an economic recovery when the economy in question is actually growing. A slower rate of contraction doesn’t count. As of late June, except for the several Asian economies that didn’t stop growing during this downturn, a slower rate of contraction was the order of the day in most economies. There is a possibility that we will see some growth in the United States and/or Canada this summer, but it seems more likely it will occur in the fall. What we can expect at a minimum in the summer is much less in the way of economic contraction.

We would all like to see a rapid recovery (though not so rapid that it contributes to upward pressure on prices), but above all, we would like to see some economic growth — rapid or otherwise — because growing economies are much more likely to provide the conditions under which companies make money. That is important because earnings are a critical driver of markets.

Many of the forecast commentaries — particularly those from the large international organizations such as the International Monetary Fund (IMF), the World Bank (WB) and the Organization for Economic Co-operation and Development (OECD) have predicted a slow recovery. To some extent this bias toward pessimism reflects both the damage that has been done to global credit markets — a major cause of the downturn — as well as the uncertainty about how quickly they will rebound.

I don’t think anyone would argue that global credit markets are currently operating optimally, but they have come an exceptionally long way since the dark days of late 2008. Progress varies among regions. The success of recent corporate bond offerings suggests that Canadian credit markets (which were, of course, much less damaged than those in many other countries) are doing well. We would be foolish to forget that the pervasive failure of risk management in recent years is resulting in more careful risk management now, a trend that will most likely continue into the future.

The shape of the recovery will also vary among the different regions of the world. Europe is likely to experience a slow recovery, partly because the European economies as a whole are not quite as robust or as structurally sound as those in North America — despite the obvious difficulties in the United States. Nor are the policy responses to the downturn as co-ordinated in Europe as they are here in North America.

Latin America is likely to experience a strong rebound, having avoided most of the financial market problems, though notably not the economic consequences of the fall in global commodity prices. Most Asian economies slowed, but didn’t stop — the sharp contraction in Japan being the exception — and they are poised to resume their globe-leading growth. The implied pickup in the demand for commodities is, of course, good for Canada.

The United States is the economy that has many people concerned, not to mention the state of the U.S. consumer. Much has been made of the fact that the consumer plays such a large role in the U.S. economy (as much as 70% of economic activity, compared with a range of 55% to 60% in Canada). Clearly, the average U.S. consumer is in rebuilding mode, i.e. rebuilding savings and repairing personal balance sheets. In addition, the U.S. economy has been losing jobs at a relatively high rate.

That means that we cannot expect U.S. consumers to play as great a role in leading the economy out of this recession as in the past. That doesn’t mean that consumers won’t make a contribution. Indeed, there are other areas of the economy that will contribute. In the near term, government spending will provide a boost. Business investment has been extremely weak recently, but it should begin to claw its way back just about the time that the government stimulus programs will be winding down.

And there is the hidden good news story concerning the U.S. economy: exports. It took exports several years to respond positively to the lower U.S. dollar (which began falling in 2002). But they did, and until the U.S. major export markets felt the economic downturn, exports were a bright part of the U.S. economic picture. Is there a guarantee that these other sources of growth will completely compensate for what consumers may not be able to accomplish? Of course not. But they shouldn’t be ignored either.

This brings us to Canada. The Bank of Canada governor reportedly told those at a private meeting in June that the recession in Canada is as bad (presumably in terms of the depth of the economic contraction) as that in the United States. He also reportedly said that Canada may grow twice as fast during recovery as the U.S.

While the governor’s remarks can’t be documented, they are consistent with some things that can be. The recovery in the emerging economies such as China will be good for Canadian commodities, as the recent strength in oil prices attests. We know that our financial institutions are in much better shape than those in the U.S. And Canadian consumers, while facing large personal debt loads and falling employment, are not dealing with anything like the same housing and housing-related issues as their U.S. counterparts. Finally, the Canadian Composite Leading Indicator (the subject of last month’s column) has not yet turned positive, but in May it showed its smallest decline in the last nine months.

So where does that leave us? We are pretty certain that an economic recovery is set to begin in the fall and strengthen in 2010 and beyond. We are also pretty certain that it will be uneven around the globe and among individual economic sectors. However, this is not significantly different from many past economic recoveries. There are risks to the recovery, as there are to virtually every economic recovery. To give the risks a proper discussion, I’ll defer them to next month’s column.

Peter Drake is vice-president, retirement & economic research, for Fidelity Investments Canada. With over 35 years of experience as an economist, he leads Fidelity’s research efforts in examining retirement in Canada today.


Peter Drake