Diversification Key To Canada’s Economic Future by Nikita Pillai, Consultant, Canada Investment Management – FactSet

Following a speech last week from Carolyn Wilkins, Senior Deputy Governor at the Bank of Canada, it looks like it’s back-to-school mode for Trudeau and Canada’s policy makers.

With Wilkins commenting on structural trends, the risks of secular stagnation, Canada’s housing dilemma, and the long road to financial stability for the economy, the administration appears to have its work cut out for them. Specifically, the Canadian economy’s dependency on the real estate sector is at the center of Ottawa’s attention as policy evaluations take place.

Related: Foreign Money Heating up Canadian Housing Market

While some parties may welcome a cooling regional housing market, the Canadian economy is unlikely to be a benefactor of decreasing demand. This is especially true given that the real estate sector is now Canada’s biggest GDP contributor and the fact that the economic shift from energy extraction to manufacturing exports intended by two overnight target rate cuts (since the end of 2014) and the depreciation of the Canadian dollar never occurred.

Triggering a big drop in home sales could have a significant impact on the Canadian economy in a year where crude oil prices hit a 13-year low and the oil and gas sector’s share of total GDP subsequently saw a pronounced decline.

Diversification Canada

Canada

Since September 2006, manufacturing output is down almost 8% while the real estate industry has surged 34% in the same period.

Why Real Estate?

The Canadian real estate sector’s strong performance, sizeable dividends, and consistent return on invested capital over the last year validate why many investors (notably major Canadian pension funds) have been active in the space.

The Ontario Teachers’ Pension Plan Board (Canada’s largest single-profession pension plan with $171.4 billion in net assets), for example, devotes almost 14% of the Board’s portfolio to REITs. As of June, real estate development, rental, and leasing were also included in the top 10 industries the Board is invested in.

Diversification Canada

While rising home prices benefit investors from an asset valuation perspective, and the accompanying wealth effect has saved the economy from severely dipping when other major sectors have disappointed, reliance on the real estate market poses a significant risk to the health of the Canadian economy. In this situation, it is crucial for the government to assess whether a policy mix focusing on limiting demand will alleviate the problem or lure the housing market into a sudden crash that could create immeasurable negative repercussions for the Canadian economy.

A Need for Diversification

Many of Canada’s major trading partners are facing increased financial stress, and a strong reliance on energy markets and exports has led to a contraction of Canada’s GDP this quarter. With that in mind, policy makers need to focus efforts on diversifying the Canadian economy, now more than ever.

Trudeau’s plans for investment into infrastructure could trigger a much needed multiplier effect that creates growth for the economy and better positions the administration to make policy changes that target economic diversification. To complement Trudeau’s infrastructure plan, there are also plans to channel investment into Canada’s technology and innovation sector. Higher startup rates and a productive small business sector will aid in spreading the weight of GDP contributions across more sectors–unlike the current situation where over 20% of GDP last quarter came from just three groups: mining, oil, and gas extraction; real estate; and rental and leasing.

At this point the Canadian economy requires not just monetary policy changes to address its structural problems, but a mix of demand and supply side fiscal policies, too, in order to boost growth.

The Canadian economy requires not just monetary policy changes, but a mix of demand and supply side fiscal policies to boost growth.

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