navigating 2019

RBC Economics Research Navigating 2019 9 big insights for the year ahead

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2019 will put Canada’s economy to the test ot since the financial crisis have markets ended the year with such uncertainty as Nthey did in 2018. Last year’s final trading days, and weeks, sig- nalled a worrisome divergence in views about the economy, global trade and policy predictability that will likely continue into 2019. For years, consumers have been our undisputed economic heroes. As each crisis or shock unfold- ed, households could be depended on to pull out their credit cards and add to their mortgages. The aftershocks of the Great Recession would have been far worse without household spending to mask slow business investment and exports. RBC Economics ResearRBC Economics Research ch | Navigat | Navigating 2019 - 9 big insights for ting 2019 - 9 big insights for the yhe year ahead | Januarear ahead | January 2019y 2019 11

We can thank low interest rates for that. Since the mid-2000s, Projected economic central bank policy rates have gone down much more than growth for 2019 up, and now that’s changing. After keeping rates at ultra-low levels for most of the past decade, the Bank of Canada has hiked them five times since July 2017 – and is expected to do so twice more in 2019. But if this year shapes up to be one of greater uncertainty, both in Canada and abroad, it won’t be solely because of the overextended consumer. Globalization is being challenged, 1.7% with the U.S. administration engaging in a trade war with China, and the UK’s exit from the EU proving to be far from graceful or predictable. Is it too much to expect the economic boom to continue? This year will mark the 10th anniversary of expansion for the U.S. economy, which remains the world’s largest single engine of growth. That would set a record if it continues past mid-year, and would put the economy, without much doubt, closer to 2.5% the end of the boom than the beginning. Against this backdrop, we set out here to examine some of the trends that will unfold in the year ahead – the risks to watch for and the opportunities to be had. Coming into 2019, the U.S. economy was on firm ground, with growth projected to slow mildly, to 2½%. Canada enjoys sev- eral advantages, including strong population growth, an increasingly dynamic economy and our continued embrace of free trade, though we also face pressure from lower-than-ex- pected oil prices and tightening financial conditions. Add all this together, and we still believe it’s premature to say this year will mark the end of the expansion. So what will keep growth going? After years of ultra-low interest rates, it will have to be more than the consumer. In 2019, the economy may finally have to stand on its own. RBC Economics Research | Navigating 2019 - 9 big insights for the year ahead | January 2019 2

A fabled recession indicator worth watching The shape of the yield curve – that is, the spread remained slightly positive. These moves were seen in between long- and short-term interest rates – is a hot Canada too. It pays to watch movements in the yield topic these days. When long-term rates are below curve, because if it inverts, this compresses inter- short-term rates, the yield curve is said to be “invert- est rate margins and makes lenders less willing to ed,” and a potential signal that a recession is not far extend credit. That would have a knock-on effect for off, with the typical lag around 18 months. While the business activity. Business loan growth in Canada spread between two- and five-year U.S. Treasuries accelerated in 2018, so we’ll be watching to see if inverted in early December, a more accurate gauge, that trend continues this year. the spread between two- and 10-year Treasuries, When the U.S. yield-curve turns negative, a recession has followed Spread between 10-year and 2-year yield, in basis points 300 250 200 150 100 50 0 -50 -100 -150 -200 -250 19 199 1982 1985 1988 1991 199 199 2000 2003 200 2009 2012 2015 2018 Source: US Treasury, NBER, RBC Economics Research Source: US Treasury, NBER, RBC Economics Research It pays to watch movements in “ the yield curve, because if it inverts, this compresses interest rate margins and makes lenders less willing to extend credit. ” RBC Economics Research | Navigating 2019 - 9 big insights for the year ahead | January 2019 3

1 A golden decade of household wealth creation is losing its lustre eclining interest rates over the past decade didn’t just make the cost of borrowing cheaper for households. $ DThey also had a hand in pumping up asset values 20,000 and household wealth in Canada. While it wasn’t shared by average annual gain everybody – far from it – net worth per household soared by in net worth over the 56% over that period, which represented an average gain of a little more than $20,000 per year per household in today’s past decade dollars. A booming housing market was a big factor, with homeowners’ equity in real estate (the value of households’ real estate assets less mortgage debt) rising by an average of $7,800 annually. Still, it was significant growth in financial assets that contributed most by adding $12,200 per year on average to households’ balance sheets. A strong economy certainly helped fuel assets such as equities and investment funds but so did low interest rates, especially for the valua- tion of future pension plan benefits. RBC Economics Research | Navigating 2019 - 9 big insights for the year ahead | January 2019 4

RBC housing forecast Canadian households have gotten wealthier for 2019 over the last decade (% change from 2018) Average increase in assets, per household per year, since 2008 in constant 2018 dollars Sales Prices $12,200 Vancouver 0.0% -2.5% $5,700 – Equity & Investment Fund shares $4,300 – Life insurance & pensions Calgary 1.0% 0.5% $7,800 $2,300 – Currency & deposits –$100 – Debt securities Toronto 5.6% 0.5% Montreal 2.6% 4.0% $1,000 Owners’ equity Financial Household in real estate assets disposable income Source: Statistics Canada, RBC Economics Research Our view is that “ housing prices will be With interest rates now climbing, expect dynamics to change for both sides largely flat in the near of households’ balance sheets, not just liabilities. On the asset side, we term (in part due to see more limited growth prospects in real estate holdings. Our view is that housing prices will be largely flat in the near term (in part due to rising rates) rising rates) and the and the ownership rate will decline in Canada, due to affordability issues. ownership rate will Some downward pressure is also likely to build on the value of households’ decline in Canada, future pension plan benefits. So after a strong decade-long run of aggregate household wealth growth in due to affordability Canada, we may be facing a slower rate of appreciation over the next little issues. while. If this is the case, much will rest on (so-far meagre) income gains to ” ease the impact. Bar to home ownership Projected share of income, 2019 88% 79% of income of income Vancouver Toronto RBC Economics Research | Navigating 2019 - 9 big insights for the year ahead | January 2019 5

Housing affordability to worsen Policy makers likely give themselves high marks for guid- ing Canada’s housing market to a soft landing in 2018, yet there has been no improvement in affordability. The bar to home ownership is higher than ever in Vancouver and Toronto, where a typical household would need to spend a record 88% and 76% of its income, respectively, to pay the mortgage, property taxes and utilities for a home pur- chased today. The bar will get even higher in 2019, as the Bank of Canada continues to hike rates. Add in tougher mortgage stress-test rules and some first-time buyers will be looking at a very high hurdle. Home ownership costs relative to incomes will rise Home ownership cost at market value as a % of median household income 100 2018 Q2 2019 Q4 90 88.488.4 79 7 .3 5. 80 9 70 60 53. 56 9 50 43. 46.8 46 9 44. 39 1 . 40 38.6 7 29 30 28.4 .4 20 10 0 Canada V ancou er Calgary Edmonton T or onto Ottaw a Montr eal aedonC orecated€nteretrateand‚oue‚old€ncomeƒ„ee…€ng‚ome…r€ceunc‚anged. †ource‡ˆ†ƒ†tat€t€cCanadaƒan„oCanadaƒCEconom€ceearc‚ * Based on RBC’s forecasted interest rates and household income, keeping home prices unchanged. Source: RPS, Statistics Canada, Bank of Canada, RBC Economics Research RBC Economics Research | Navigating 2019 - 9 big insights for the year ahead | January 2019 6

2 The average household faces a $1,000 hit from rate hikes ighteen months in, Canadian households have yet to Average household feel the full brunt of the Bank of Canada’s interest- principal and interest Erate hiking cycle, from the increases that have already payment happened and those yet to come. The amount of interest households pay is poised to rise in the year ahead – adding Increase to increases households were forced to absorb in 2018. 7.6%in 2019 In this age of elevated household-debt levels, even small upticks in interest rates can produce large increases in interest payments. We estimate an aver- age household will pay about $1,000 more in 2019 to service its principal and interest obligations. That would represent a 7.6% jump from 2018 – a tough pill to swallow for many. Rising incomes, however, will provide a buffer. We expect average disposable income per household before debt-service obligations will grow by $2,300 in 2019. This means that after servicing its debt, the aver- age Canadian household will end up with $1,300 more in its pocket. A nice cushion like this will keep a majority of households out of trouble. The question, though, is whether it will be enough to cover the rise in the cost of other goods and services. For many Canadians, it probably won’t. Expect some belt-tightening in the year ahead. RBC Economics Research | Navigating 2019 - 9 big insights for the year ahead | January 2019 7

Household debt payments will rise in 2019 The average “ Annual increase in debt service obligations per household household will end up in Canada, in dollars with $1,300 more in its ,200 pocket ,000 978 ” 00 790 00 504 00 200 75 0 20 20 20 20 * Including debt-free households. Source: Statistics Canada, RBC Economic Research * Including debt-free households. | Source: Statistics Canada, RBC Economics Research Consumers will pay fewer visits to the car lot Even before being pinched by rising interest rates, fewer population aged 16 and over. Auto sales in Canada peak- Canadians were buying autos, in part reflecting a potent ed in 2017. That was a year after peak-vehicle sales in the combination of technology and demographics. For U.S., but the decline in Canada has been sharper. Now, those living in urban areas there’s been an explosion add in the impact of higher interest rates, which will eat in ride-sharing and car-sharing services, like Uber and into household discretionary income and force some ZipCar, while research has found the number of young consumers to decide just what they can live without. people with driver’s licenses has been waning. Another Will a new set of wheels be near the top of that list? way to look at this is auto sales adjusted for Canada’s Peak auto sales in Canada and the U.S. is behind us Unit auto sales per 1000 population age 16+ 85 80 S Canada 75 ecast For 70 65 60 55 50 45 40 10 12 14 16 18 2000 2002 2004 2006 2008 2010 2012 2014 2016 2018 2020 Source: BEA, Statistics Canada, RBC Economics Research Source: BEA, Statistics Canada, RBC Economics Research RBC Economics Research | Navigating 2019 - 9 big insights for the year ahead | January 2019 8

Rising interest rates will squeeze Federal public debt government spending… charges as a share Households won’t be alone in feeling pressured by rising interest rates. of GDP Governments will also see their spending options limited as they have to earmark more money for debt charges. Consider the federal government’s fiscal outlook. Relative to other expenditure items, federal debt-servicing costs will account for the second-largest increase in federal spending from fiscal 2017-2018 to fiscal 2023-2024. Only one other item will increase faster: benefits for the elderly. To be sure, as a share of GDP, federal public debt charges – at 1.2% – are small compared to the 5%-6% witnessed in the late 5%-6% 1980s and into the 1990s. At that time interest rates were in the double dig- 1980s & 90s its. Nothing like that is going to happen during this round of tightening by the Bank of Canada. However, with growing demands on the public purse from an aging population, higher debt charges will account for an increas- 1.2% ing part of the equation limiting funds available for other priorities. Today Ottawa will spend more on debt payments than almost any program Federal government spending growth, FY 2017-18 to 2023-24, billions of dollars Elderl eneﬁts €ulic det charges Canada Health Transfer ther transfer pa ments Emplo ment nsurance eneﬁts Eualiation Children’s eneﬁts Canada Social Transfer perating expenses Home care and mental health Territorial Formula Financing Gas Tax Fund 0 5 10 15 20 Source: Department of Finance, RBC Economics Research Source: Department of Finance, RBC Economics Research RBC Economics Research | Navigating 2019 - 9 big insights for the year ahead | January 2019 9

…And impact corporate balance sheets Canadian companies also ran up debt balances as low interest rates spurred spending on residential structures and capital goods. Slower growth and softer housing construction in 2019 will likely weigh on credit demand. Canadian companies borrowed more heavily than their international counterparts Percent of GDP 120 Advanced Economies Canada 110 100 90 80 70 2000 2002 2004 2006 2008 2010 2012 2014 2016 2018 Source: BIS, RBC Economics Research Source: BIS, RBC Economics Research Two big new revenue streams for governments in 2019 $6 billion $400 million The amount of money Ottawa and the prov- The total amount the federal and provincial inces will collect from various carbon pricing governments expect to collect from cannabis schemes in fiscal 2019-2020. Governments duties this year. Ottawa alone anticipates it aren’t keeping it all. In several provinces, much will bring in $100 million, the federal govern- of carbon revenue will be returned to house- ment’s maximum take in the first two years holds in the form of rebate cheques. of legalization under a revenue-splitting deal with provinces. RBC Economics Research | Navigating 2019 - 9 big insights for the year ahead | January 2019 10

3 Labour shortages could finally lead to wage growth ith the Canadian economy running close to full capacity in 2018, the bigger story was labour short- Wages. The national jobless rate hit a 44-year low 547,300 in November, and the latest data showed more than half a number of job million unfilled jobs, up nearly 100,000 from the same point in openings 2017. Businesses surveyed by the Bank of Canada and other groups consistently said they were having an increasingly in Canada tough time finding and hiring workers. * As of June 2018 There’s little relief in sight. Overall, employment rates remain two percent- age points below pre-recession heights, a situation unlikely to change due to the steady aging of the Canadian workforce. Retirement rates are steadily increasing, participation rates of youth (especially young men) remain flat or are declining, and women of prime working age continue to participate in fewer numbers than their male counterparts. Immigration has historically provided a significant source of new workers to Canada, but increases con- templated in the near term will likely be insufficient to satisfy the increase in demand for workers. Policies to bring more people into the labour force – expanded childcare programs or increased investments in work-integrated learning – could help address labour shortages. RBC Economics Research | Navigating 2019 - 9 big insights for the year ahead | January 2019 11

Historically, worker shortages have spurred increases in wages. The fact that significant wage growth hasn’t materialized this time around remains More Canadians a puzzle for economists and policy makers. Our take is that, while labour “ markets continue to look like those at the beginning of the last expansion have been leaving in 2004, changes in demographics and behavior are affecting the wage their current jobs – a response. A decrease in labour turnover – Canadians’ reluctance to leave factor that suggests their jobs for greener pastures – is one factor that appears to have limited wage growth. However, in the past year, more Canadians have been leaving stronger wages their current jobs – a factor that suggests stronger wages ahead. ahead.” 270,000 Throughout the 2020s more than 270,000 people will retire from the Canadian labour market every year. That means that 2019 is the year businesses have to get serious about attracting and keeping younger workers. More Canadians are leaving jobs because they’re unhappy % of labour force 0.6 0.5 0.4 0.3 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 Year to date Unemployed people who left their jobs because they were ‘dissatisfied’ as % of labour force Source: Statistics Canada, RBC Economics Research RBC Economics Research | Navigating 2019 - 9 big insights for the year ahead | January 2019 12

4 Jobs at risk of automation see losses ver the years countless headlines have warned of the threat robots pose to jobs, and yet employment has continued to rise. We are now, however, starting to see Othe automation of certain jobs being reflected in labour statistics. We can see that by looking at the employment growth of jobs most “at risk” of being made obsolete through Jobs most at risk of automation technological advances, compared to growth in jobs saw negative growth that face a “moderate” or “low risk” of automation. Over the last five-year period, jobs in the “at risk” Growth in employment by risk of automation, category actually experienced declining employment, 2013-2018, % while employment in “low risk” occupations soared. 8 Not all “at risk” jobs saw declines – food service workers, 7 administrative assistants and bookkeepers all enjoyed 6 5 strong employment growth. Still, we see no reason to 4 expect this broader transformation of the job market 3 to reverse. 2 1 The thing to remember is that automation of jobs 0 doesn’t mean jobs are going away. While new technol- -1 Low Risk Moderate Risk High Risk ogies can disrupt employment by replacing workers directly, it can also reduce costs and drive expansions such that overall employment grows. What’s needed Source: Statistics Canada, RBC Economics Research, is for policy makers to play a greater role in helping and Frey and Osborne (2017) workers through this adjustment, with more resources put towards education and training to help mitigate the disruptive effects of automation. RBC Economics Research | Navigating 2019 - 9 big insights for the year ahead | January 2019 13

5 Canada’s not-so-secret growth weapon: immigration hen it comes to population growth, Canada leads the G7. Indeed, no other country in the group Wcomes close. In 2018, Canada’s population was 350,000 on track to increase 1.4%, the strongest pace in 18 years Canada’s target and double the 0.7% rate for the U.S., the G7 country with number for the next-highest population growth rate. Strong (net) immigration accounted for almost half (45%) of Canada’s pop- immigrants ulation increase last year. That contribution will only grow, since Ottawa has by 2021 committed to boost its annual immigration target from 310,000 new perma- nent residents in 2018 to 350,000 by 2021, with a big jump of 6.7% to 331,000 scheduled for 2019. About two-thirds of 2019’s increase will come from the economic programs that target highly skilled workers and are aimed at ad- dressing labour shortage issues across Canada. RBC Economics Research | Navigating 2019 - 9 big insights for the year ahead | January 2019 14

Growth in non-permanent residents was the other noteworthy development in 2018. The number of foreign nationals admitted to live in Canada on a Share of population temporary basis reached an all-time high of 166,000 (net of returning individu- growth from als), which represented about one-third of the total rise in population. That’s up from less than 10% two years ago. This group includes temporary foreign non-permanent workers, international students and asylum seekers. All three categories residents: soared, reflecting strong demand for skilled labour, Canada’s growing reputa- tion as a desirable place to obtain post-secondary education, and increases in cross-border refugee claimants. We see little in the short term that would reverse these trends. Canada’s population grew faster than all other G7 countries Annual % change in resident population, 2018 2.0 1 1.5 .4 1.0 0 0 . . 7 7 0.5 0 .3 0 .2 0.0 -0 -0 .2 .2 -0.5 Canada US UK France Germany Italy Japan Source: Statistics Canada, US Bureau of the Census, Eurostat, INSEE, Germany’s Federal Statistical Office, ISTAT, Japan’s Statistics Bureau, RBC Economics Research RBC Economics Research | Navigating 2019 - 9 big insights for the year ahead | January 2019 15

6 Canadian oil won’t plumb 2018 lows he Alberta government’s remarkable intervention in the oil sector at the end of 2018 will carry over into the Tnext 12 months and beyond. 1.2 million Having first agreed to buy 7,000 railcars, the province then announced pro- barrels/day: OPEC’s duction cuts to clear bloated inventories and help the price of Canadian oil production cut, which move closer to global benchmarks. But these actions won’t have any impact on global prices as that responsibility lies in large part with OPEC, which on should help oil prices December 7 announced plans to cut production by 1.2 million barrels per day to boost oil prices. Lower global supply means the market will get closer to balance in 2019. This is good news for Canadian producers as well, given that the spread between WTI and Western Canadian Select is also moving in a positive direction. The price gap between Canadian and international oil 50 $US per barrel 40 Differential between WCS and WTI 30 price, in US$ per barrel 20 10 0 2010 2012 2013 2014 2015 2016 2017 2018 Source: Bloomberg, RBC Economics Research RBC Economics Research | Navigating 2019 - 9 big insights for the year ahead | January 2019 16

7 Oil elbows out other sectors in rail transport anadian oil producers shipped more than 200,000 barrels a day of oil by rail last summer – a record high, Crude-by-rail is Cand nearly double the amount they shipped in the “ causing problems summer of 2017. But what has been a saving grace in dealing for other with transportation bottlenecks caused by a lack of pipeline commodities. capacity has turned into a problem for shippers of other ” commodities. Rising crude-by-rail shipments have served to elbow out grain and metals in particular. In 2018, grain farmers were particularly vocal in their complaint that rail companies were prioritizing oil shipments over grain, keeping them from getting their product to market in a timely manner. There might be some relief this year. In addition to Alberta’s railcar purchase and production costs, replacement of Enbridge’s Line 3 is expected to add 370,000 barrels a day of pipeline capacity in the second half of 2019. At the same time, oil sands producer Cenovus signed three-year deals with Cana- da’s two big rail companies to move 100,000 barrels a day of heavy crude by rail, suggesting crude-by-rail will continue to play a role in 2019. RBC Economics Research | Navigating 2019 - 9 big insights for the year ahead | January 2019 17

Oil shipments by rail compared to other commodities Change in average daily carloads from 2008 to 2018, in thousands Petroleum products Crushed stone, sand and gravel Chemicals arm products ecluding grain umer and ood products ood products Coke Motor vehicles and parts All other Stone, clay and glass products Grain mill products Coal Primary forest products Waste & scrap materials Primary metal products Nonmetallic minerals Grain Metallic ores Pulp and paper products -2 -1 0 1 2 3 4 5 Source: Association of American Railroads, RBC Economics Research RBC Economics Research | Navigating 2019 - 9 big insights for the year ahead | January 2019 18

8 Competitiveness measures will look beyond taxes fter more than a year of mounting anxiety in Canada about the competitive threat from U.S. corporate Businesses say Atax cuts, the federal government’s Fall Economic “ red tape is a bigger Statement won praise from business leaders for the suite problem than taxes of tax measures it contained, such as accelerated capital for competitiveness expensing. That, coupled with the fact Canada’s corporate ” tax rates remain the third-lowest in the G7, should help Canada’s competitive landscape in 2019. But competitiveness is not all about taxation, and improvements don’t always have to cut drastically into government revenues. Inefficient government bureaucracy ranks above tax rates as a “problematic factor for doing busi- ness” in Canada, according to the World Economic Forum. Consider the aver- age time it takes to deal with construction permits: at 250 days, according to World Bank data, the process takes longer than in any other G7 country, and almost three times as long as in the U.S. The seemingly endless process to get new oil pipelines built to alleviate Canada’s oil transportation bottlenecks is another example. RBC Economics Research | Navigating 2019 - 9 big insights for the year ahead | January 2019 19

On this front we see progress in 2019, too. The federal budget update included several new deregulation initiatives, including a top-down review of Canada’s Foreign direct red tape regimes, more emphasis put on the economic impact of government “ rule books, an agency focused on regulatory innovation, and the introduction investment in of a “regulatory modernization bill” to be reviewed annually in search of Canada is finally “outdated or duplicative” rules. picking up. Notably, Canada’s competitiveness challenges haven’t prevented a pickup ” in business investment. Foreign direct investment in Canada during the first three quarters of 2018 is already ahead of the total inflow of investment in all of 2017, albeit still at historically low levels. At the same time, a new generation of businesses is being created, which is vital to job growth. The existence of competitiveness constraints doesn’t mean there will be no investment growth. The thornier question is how much more growth there would have been if they hadn’t been there. Dealing with Construction Permits - Time (days) 300 250 200 150 100 50 0 United United Germany France Japan Italy Canada States Kingdom Source: World Bank (doingbusiness.org), RBC Economics Research RBC Economics Research | Navigating 2019 - 9 big insights for the year ahead | January 2019 20

More firms, more jobs For an economy to thrive it needs entrepreneurs to take of 2018 running at its fastest pace since 2012. Growth was risks, launch new ventures and, importantly, create jobs. led by the transportation and warehousing sector, one For too long, Canada’s net firm creation – a measure of of the strongest economic performers in recent years. the number of business in the country that reflects new And for an economy looking forward, the information and enterprises opening and failed businesses closing – was communications technology sector emerged as a growth on a downward trajectory. By 2015 it flat-lined amid a star in 2018. Need another reminder why net firm creation pullback in the oil and gas industry. We’ve seen a recov- matters? In 2017, it resulted in 100,000 new jobs being cre- ery since then, with net firm creation over the first half ated, and was on track for a similar gain in 2018. More new businesses are being created than at any time since 2012 Net firm creation (entry rate less exit rate), percent 1.6 1.4 1.2 1.0 0.8 0.6 0.4 0.2 0.0 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 Source: Statistics Canada, RBC Economics Research In 2017, net firm creation resulted “ in 100,000 new jobs being created, and was on track for a similar gain in 2018. ” RBC Economics Research | Navigating 2019 - 9 big insights for the year ahead | January 2019 21

9 Canada would be caught in the crossfire of a U.S.-China trade war oncerns about Canada’s most important trade rela- 2017 Global Exports tionship eased when the USMCA deal was struck in and Imports Clate September. It’s true that bilateral irritants remain and the USMCA has yet to be ratified. Nonetheless, the focus in Canada has shifted to possible repercussions from the escalating trade spat between the U.S. and China. The good news, if it can be called that, is that the U.S. administration is U.S. $5.3 developing a reputation for ramping up rhetoric in disputes before ultimate- trillion ly agreeing to a “new” deal with relatively minor tweaks. We saw that with the talks to update NAFTA. As it stands, the administration and China have agreed to a trade war truce to start the year. And while the US$360-billion of China $4.6 U.S.-China bilateral trade that has already been targeted with tariffs is an trillion eye-catching number, it pales in the global context. U.S. exports and imports totaled about US$5.3 trillion in 2017; for China, it was US$4.6 trillion. Yet a meaningful escalation in the U.S.-China trade dispute can’t be ruled out. The impact on Canada would be mixed, but tilted to the downside. Model simulations from the IMF’s latest World Economic Outlook have even shown some potential near-term benefits to Canada and Mexico, as Chinese and U.S. businesses and households shift trade to other partners. That would please Canadian exporters looking to develop more significant trading relationships with China. RBC Economics Research | Navigating 2019 - 9 big insights for the year ahead | January 2019 22

Products subject to U.S. and China tariffs A full-blown trade relative to total trade “ conflict would have $US billions negative impacts on Canada. 6000 ” 5000 4000 3000 2000 1000 0 $US 360 billion U.S. trade China trade (US $250b tari + (exports + (exports + $110b China imports) imports) retaliation) Source: World Bank (doingbusiness.org), RBC Economics Research But we doubt the impact on Canada would be that benign. Taking full advan- tage of trade opportunities emerging from a U.S.-China trade war would probably require expensive investments to reorient supply chains which currently keep demand for Canadian products inextricably tied to demand for U.S. products. Efforts are underway to change that, but in the short run those expenditures could be hard to justify given the potentially temporary nature of the U.S.-China trade disruption. On the other hand, a full-blown U.S.-China trade conflict would have imme- diate and negative impacts on Canada, through stock market volatility that could affect business and consumer confidence, as well as the potential for higher prices from tariffs making their way into broader supply chains and onto the backs of households. The best Canada and the world can hope for is that the current trade truce not only holds, but leads to existing tariffs being scaled back. RBC Economics Research | Navigating 2019 - 9 big insights for the year ahead | January 2019 23

Free trade deals will pay off for Canada, but we need more action While too many countries are devoting energy and tariff reductions in January 2019. The CETA and CPTPP resources to erecting walls along their borders – both together are estimated to add about one-half of a per- of the physical and tariff variety – Canada remains a centage point to Canadian growth over the long term. Of steadfast believer that a freer flow of goods, services course, having trade deals doesn’t automatically trans- and people between nations is key to unlocking eco- late into more trade. Canadian companies must do more nomic potential. In addition to Canada’s Comprehensive to take advantage of their access to global markets. While Economic and Trade Agreement with Europe, which came our country will continue to be tied closely to our south- into force in 2017, the Comprehensive and Progressive ern neighbour, these trade agreements give Canada a cru- Trans-Pacific Partnership will deliver its first round of cial head start at a time when the U.S. is turning inwards. “The CETA and CPTPP together are estimated to add about one-half of a percentage point to Canadian growth over the long term. ” RBC Economics Research | Navigating 2019 - 9 big insights for the year ahead | January 2019 24