Ontario Economic Update August 2018: Changing trade winds

Ontario Economic Update August 2018: Changing trade winds

Economic Update Takeaways:

  •  Ontario's unemployment rate for the core working age (25-54) has risen 0.3 percentage points to 4.9 percent since the start of Q1 2018, the highest among our peer provinces.
  •  Real median hourly wages have fallen slightly to $25.60 during Q2, but are still up from $25.00 in January 2018.
  •  Service sector occupations have seen the largest increases in wages since January 2017, especially the financial, wholesale, and professional services industries.
  •  Ontario is much more dependent than Québec or British Columbia (Ontario’s peer provinces) on a few US export markets.
  •  Over 25 percent of exports are automobiles, threatening Ontario’s economic leadership in the face of trade and political uncertainties.  
  •  Services are the fastest growing export sector and provide an opportunity to diversify Ontario’s exports.

Statistics Canada’s latest release of economic indicators shows that Ontario’s momentum continues forward, albeit at a slower pace. Unemployment held steady at 4.9 percent in June, but was accompanied by a seven-cent loss in real median hourly wages. Nevertheless, they are up by 60 cents since January, largely due to increases in the services-producing sector, where hourly wages have been rising healthily over the past 15 years, while manufacturing wages have remained mostly stagnate or declined over the same period, especially in recent years (Exhibit 1). Coincidentally, service-based industries are also the ones with the fastest growing export markets, indicating a transforming trade balance based on the exports of services which more closely reflects Ontario’s GDP composition.

Exhibit 1: 12-month moving average of real median wages in goods and service-producing sectors, Ontario, 2001-2018 (monthly)

Trade uncertainty threatens to expose Ontario’s weaknesses

Ontario’s economy is the engine of Canada, representing over one-third of national GDP and over 40 percent of exports. This status can be attributed to strong specialization in the domestically-focused services sector and the export-oriented manufacturing sector. Over the last decade, 99 percent of Ontario’s increase in GDP can be attributed to the services sector which now represents nearly 78 percent of the provincial economy. However, while manufacturing comprises just 22 percent of the GDP, it currently stands at 58 percent of total exports.

This is where Ontario’s advantages can become its weakness: While relative strengths are capitalized upon domestically, the relatively smaller manufacturing sector makes up the bulk of exports. Manufacturing - especially in the automotive sector - may have been the economy’s forte in the past, but the entrance of developing markets and new supply chains are making it increasingly difficult for Ontario to compete in this domain. It is therefore all the more imperative that the export of services be encouraged – not only to increase provincial GDP but in order to remain internationally competitive.

Too few trading partners

Exports drive economic growth and yet, despite Ontario’s domination of total Canadian export volume, the province has very few export partners. Of the goods and services that leave the province, only 27 percent are slated for interprovincial trade compared to 34 and 44 percent for Québec and British Columbia, respectively (Exhibit 2). Of the fraction of products that leaves national borders, about 80 percent goes to the American market. Furthermore, over half of the province’s US exports go to just a handful of US states (Exhibit 3).

Exhibit 2: Interprovincial and international trade flows, Ontario, provinces, and rest of the world, 2014

Exhibit 3: Export Destination by largest markets, Ontario, May 2018

Too few traded goods

As mentioned above, the manufacturing sector accounts for about 58 percent of Ontario’s exports despite being just over a fifth of the total economy. A single NAICS code within the manufacturing sector, the automobile and light duty motor vehicle manufacturing industry accounted for nearly one-quarter of Ontario’s exports in 2017. Most automobile exports were sent to either Michigan (55 percent) or California (40 percent). British Columbia and Québec, likewise, have dominant industries, however the imbalance is not to the same degree as that found in Ontario. (Exhibit 4). For comparison, Michigan’s top export (spark engines) is under nine percent of its total exports and its largest trading partner, Canada, is about 42 percent of its export market. Even though programs such as the Ontario Chamber of Commerce’s Global Growth Fund or Export Development Canada offer export assistance across both sectors to Ontario businesses, these tend to focus on the goods-producing sector over services, perpetuating the dominance of manufactured goods in the export market.

Exhibit 4: Market share of top 3 exports by province, Ontario and peer provinces, 2017

To reduce the dominance of a few, large industries, focus should turn to the quickly growing services sector. Wholesale, finance, administrative support, professional services, and transportation services have all seen rapid growth in recent years, both in employment numbers and wages. While these industries’ exports are increasing, when compared to goods-producing industries, they are only a small fraction of overall exports. To diversify exports and increase prosperity, the province must focus on its strengths in services.  

The risks of homogeneity

Whether intentional or not, Ontario’s preference for few specialized goods exported to select trading partners via well-established industries and supply chains has helped make the province Canada’s manufacturing hub. However, with uncertainty concerning NAFTA and US rhetoric on protectionism becoming reality, Ontario stands to lose the most in a trade war. Of particular concern is President Trump’s call for a 25 percent tariff on Canadian vehicles and 10 percent on auto parts. Given that the automotive industry is twice as concentrated in Ontario compared to the rest of Canada, there is little doubt that the economy will be heavily impacted. Under such a scenario, 2019 growth could be reduced by 2 percentage points with one in five manufacturing jobs at risk.

To ensure economic longevity, it is time to expand markets and scope

While it may be foolish to fight fire with fire when it comes to imposing tariffs against the US, there are unilateral actions Ontario can – and must – take to safeguard its economic growth. Arguably the single best initiative, and one the institute has advocated for on several occasions, is to expand into markets here at home and to use this opportunity to tackle two persistent problems at once. Only a quarter of Ontario’s 2014 trade was interprovincial - largely due to provincially imposed trade barriers and regulations. This has been an issue for some decades and now is the time to begin a new initiative to standardize regulations between provinces. One study estimates that reducing external interprovincial trade costs by 10 percent can increase Ontario’s real GDP by 1.8 percent. Furthermore, within Canada, Ontario has a revealed comparative advantage[1] in communication, finance, business services, and wholesale and retail which have the potential to be leveraged in domestic and foreign trade deals.

Manufacturing has for a long time been the backbone of Ontario’s economy. Now, with cheaper, foreign competition and a dwindling domestic manufacturing base, this once proud industry is hollowing out. And with direct attacks from our largest export market, it is time to encourage the growth of services exports. Ontario is quickly specializing in finance and insurance, administration, professional, and transportation services, providing an excellent opportunity to diversify into highly skilled, high paying industries. By capitalizing on its strengths and taking advantage of these industries’ momentum, Ontario can strengthen its economy and ensure prosperity for years to come.

Written by: Weseem Ahmed​

[1] The revealed comparative advantage index is a measure of each sector’s share of a province’s total exports relative to the total-exported weighted average share across all provinces.

Summary Tables

[1] The revealed comparative advantage index is a measure of each sector’s share of a province’s total exports relative to the total-exported weighted average share across all provinces.

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