Growth After Stimulus

This morning, Statistics Canada reported a robust economic expansion in March and hence in the first quarter of 2010. Although February’s growth was revised down to 0.2%, strong growth of 0.6% in both January and March propelled the quarterly total to 1.5%.

That figure corresponds to an annual growth rate of 6.1%, more than double the 3.0% growth reported south of the border. By contrast, our annual growth rate fell short of the US in the fourth quarter of 2009 (4.9% vs 5.6%).

Today’s data shows that the Canadian economy expanded significantly despite stimulus levelling off. In 2009, government purchases and investments had accounted for a disproportionately large share of economic growth.

In the first quarter of 2010, government purchases and investments increased by only $3 billion, yet overall output increased by $20 billion. While the state continued to make a positive contribution to growth, it is no longer driving growth.

So what did drive growth? One major source was consumer spending, which expanded by $9 billion. However, this figure is not very impressive in proportional terms. Consumers account for nearly two-thirds of the economy, but contributed less than half of economic growth.

The real story was that businesses began restocking their inventories in the first quarter, which also added $9 billion to Gross Domestic Product. While business cut back production and drew down inventories throughout 2009, it is now producing to build up inventories in anticipation of future sales.

Canada’s Gross Domestic Product ($ billions)

Source

Business invested $5 billion more in building real estate. While corporate Canada also invested slightly more in machinery and equipment, it invested slightly less in non-residential structures. As a result, corporate investment flatlined (outside of housing.)

International trade was a drag on Canadian growth in the first quarter. The fact that imports increased more than exports reduced growth by $6 billion, completely offsetting the contribution from real estate.

The problem is that neither inventory restocking nor increased housing construction can continue forever. The pessimistic scenario is that, when inventories are stocked to normal levels and the real estate boom slows, we could be left with a rather sluggish economy. Allowing government investment to drop off as stimulus packages expire would make matters worse.

The optimistic scenario is that temporary growth from inventories and real estate will carry the Canadian economy until business investment and/or net exports pick up. The proactive policy response should be to maintain (if not increase) current levels of government investment at least until there is evidence of more sustainable private-sector growth.