The Lost Decade(s): or how the oil boom masked Canada’s economic mediocrity

Economic insight provided by Alberta Central Chief Economist Charles St-Arnaud. 

Key takeaways:

• Many observers have noted Canada’s underperformance in terms of GDP per capita relative to other industrialized countries since 2015. A period often referred to as “the lost decade”.
• However, little consideration and effort are put into analyzing the source of this mediocre performance. Without understanding the causes, it is difficult to provide solutions.
• Our analysis suggests that this period should be called the “Lost Decades”; plural, because the seeds for Canada’s current mediocre economic performance were planted well before 2015.
• Since the early 1990s, GDP per capita in Canada and the US has had a nearly identical trend. Similarly, Canada’s performance also followed the EU’s since 2000. However, this trend broke at the end of 2014 when Canada started to underperform meaningfully.
• The timing of the start of this divergence is particularly interesting and coincides with the drop in oil prices in late 2014. This led to a collapse in capital expenditure in the oil and gas sector. However, in the subsequent period, the non-energy sector was able to take the baton in driving Canada’s prosperity.
• Looking at the composition of GDP per capita, both by expenditures and industry, and at the drivers of the relative GDP per capita performance between Canada and the US, we reach a crucial observation: the oil boom that ended in 2014 obscured the mediocre performance of the rest of the Canadian economy, particularly in manufacturing.
• Between 2000 and 2014, investment in oil and gas would have led to an outperformance in Canada’s GDP per capita relative to the US. However, continued subpar performance in exports per capita and in the manufacturing sector fully offset this outperformance, leaving Canada’s GDP per capita to evolve in line with the US.
• Since 2014, the collapse in oil and gas investment has meant that business investment gradually became a drag on Canada’s GDP per capita relative to the US, while the underperformance in other sectors of the Canadian economy continued. In addition, weaker disposable income per capita growth post-bust also led to an underperformance in household spending per capita.  
• To understand how to boost Canada’s future prosperity, it will be crucial to understand: 1) why investment in oil and gas remains subdued despite favourable oil prices in recent years, and 2) why the non-energy sector has had such a mediocre performance over the past two and a half decades. Both will be the subject of upcoming reports.
• The lack of rebound in oil and gas investment in recent years is not unique to Canada. Globally, oil and gas companies are returning a greater share of their revenues to shareholders rather than investing in their operations. This suggests a global shift in shareholders’ preferences and that Canadian regulations, although arguably unhelpful, may not be the primary reason for the sector’s lack of investment and impact on the economy (see Where’s the boom? How the impact of oil on Alberta may have permanently weakened and Where’s the boom? And the rise and fall of the Alberta Advantage).
• A lack of competitiveness is likely the main culprit for the poor performance of the non-energy sector. As we have shown (see Canada’s housing obsession is cannibalizing productivity), chronic underspending on productive investment over multiple decades is the cause for weak productivity performance in Canada. More importantly, there is evidence that household borrowing over the past 30 years has crowded out business investment.
• This divergence between the resource and non-resource sectors during a commodity boom suggests that the Canadian economy may have suffered from “Dutch Disease”. However, our preliminary analysis suggests that globalization may have played a much bigger role in the underperformance of the manufacturing sector. More details in an upcoming report.

Many have noted Canada’s underperformance in GDP per capita relative to other industrialized countries over the past decade; however, little consideration and effort are put into analyzing the source of this mediocre performance. Without this understanding, it is difficult to provide solutions to this important issue. In this first part of our series on the “Lost Decade(s)”, we investigate the drivers of the poor performance seen in recent years.

Canada’s GDP per capita underperformance

GDP per capita is a measure often used to estimate and compare countries’ living standards. While it is far from perfect as it fails to account for inequalities or quality of life indicators (health, environment, etc.), it is still valuable due to its simplicity and widely available data across countries.

Examining GDP per capita across OECD countries, many observers have noted that Canada has had one of the worst performances since 2015, increasing by only 0.5% over the period; only Luxembourg had a worse performance during this period. In comparison, GDP per capita rose 20.7% in the US, 8.1% in Australia, 9.1% in the G7 on average.

Over a longer period, we note that Canada’s performance was similar to the performance of other G7 countries before the mid-2010s. Comparing GDP per capita for Canada, the US, and the Euro Area, we can see that they all followed a very similar trend in the 2000s.

There seem to be two periods of divergence in Canada’s GDP per capita growth.

1. Post-2014 underperformance

In the second half of the 2010s, it became evident that Canada’s GDP per capita growth slowed compared to the US and the Euro Area. The Euro Area’s GDP per capita had caught up with Canada’s on the eve of the pandemic, after underperforming significantly in the early 2010s due to its sovereign debt crisis; post-pandemic, Canada’s underperformance relative to the Euro Area continued. Beyond the Euro Area, there is a clearer divergence between Canada and the US. After following each other closely since the early 1990s, a clear break in trend may be observed by the mid-2010s, with the gap between the two countries steadily widening ever since.

The timing of the start of the underperformance is particularly interesting. Taking a closer look, the divergence between the US and Canada starts at the end of 2014. This coincides with the collapse of oil prices seen in the second half of 2014, when WTI declined from a high of $107 a barrel in June 2014 to $44.50 in January 2015, a drop of almost 60%.

The oil price crash resulted in a collapse in capital expenditures in the oil and gas sector. In 2014, spending on capex by the oil and gas industry reached a record of $76.1bn, representing about 4% of Canadian GDP. By 2016, investment had dropped by over half to $37.8bn and continued to decline until it bottomed during the pandemic. We estimate that the decline in oil and gas investment in 2015 alone reduced Canadian growth by about two percentage points. In recent years, while investment in the sector has picked up to a certain extent, it remains well below levels seen in 2014.

2. 2022 to now

The decline in GDP per capita started in 2022Q2, following the start of the Bank of Canada’s tightening cycle; this clearly indicates that the sharp monetary policy tightening had a significant impact and the Canadian economy was in a recession. As we wrote (see It’s a “Me-cession”, not a recession), this recession was largely masked by sharp population growth, which prevented an outright decline in aggregate economic activity. Our estimate suggests that, if the population had continued to grow at its pre-pandemic pace, the Canadian economy would have contracted in the second half of 2023.

An important driver of the decline in GDP per capita was a reduction in spending per capita and residential investment, as households were hit by declining purchasing power; this was due to high inflation and higher debt-service costs on record debt as interest rates increased. At the same time, business investment remained subdued, and exports underperformed our trading partners’ imports.

Looking under the hood of GDP per capita

Revealing that overall GDP per capita growth is weak is only useful if the source of the weakness is identified and understood. For that, we need to look at the evolution of the various components of GDP per capita. To do so, we look at GDP per capita by expenditure, GDP per capita by industry and the GDP per capita by province. This allows for a more holistic view of what was happening in the economy.

We look at how the various components evolve during different periods:

1. 1990 to 2000. This period provides a historical context for what was driving GDP per capita over a longer period.
2. 2000 to now. It provides the historical context from the turn of the millennium.
3. 2000 to 2014. Covers the period when Canada’s GDP per capita performance was in line with other trading partners like the US and the Euro Area.
4. 2014 to now. Covers the period that followed the oil price crash and Canada’s divergence relative to the US.
5. 2014 to 2022. This period includes the first break in the trend.
6. 2022 to now. This period covers only the second break that happened following the sharp increase in interest rate.

GDP per capita by expenditure

Looking at the average growth of the various components over the different periods, numerous observations can be made (Fig 4). Appendix A shows the evolution of each per capita component.

• GPD per capita growth was stronger between 1990 and 2000 than post-2002, with most of the slowdown happening post-2014. There are also some substantial differences regarding the growth of the components of per capita GDP. Investment in machinery, equipment, intellectual property, exports, and imports increased significantly faster on a per capita basis during that period than in the 2000s.
• On the export side, we note that exports per capita have barely increased since the late 2000s, in sharp contrast to the performance seen in the 1990s (Fig 17). What is interesting is that, with energy exports having increased over the period, non-energy exports per capita are about 10% below their peak in 2000Q3.
• Similarly, investment in machinery, equipment and intellectual property peaked in 2008 and has been on a declining trend since (Fig 15) . As a result, this component is currently 16% lower than its peak, with the decline attributable to an almost 30% decline in investment in machinery and equipment per capita.
• Residential investment per capita was weak in the 1990s. This is due to the housing crash from earlier in the decade in the early 1990s. It was strong from the mid-1990s until the global financial crisis of 2008. Afterwards, it increases more mildly, before declining in the post-pandemic period (Fig 13).
• Non-residential investment in structures skyrocketed between 2000 and 2014 (Fig 14). However, post-2014, this component saw a constant decline and is currently about a third lower than its peak. Most of the changes in investment in non-residential buildings are due to the engineering structure component, as non-residential buildings were relatively stable over the period.
• Household spending per capita has also been weaker post-2014. However, this weakness cannot be explained solely by the post-2022 period when spending per capita declined. Instead, this weakness in spending per capita can be traced to weaker real disposable income growth post-2014 bust.
• In the period since 2022, most components of GDP per capita have declined, suggesting broad-based weakness in the economy. The decline was particularly severe in residential investment, investment in machinery, equipment and intellectual property, non-residential structures, and household spending, all sectors that are interest rate sensitive.

GDP per capita by industry

Canada’s GDP by industry only goes back to 1997. Hence, the pre-2000s estimates are only calculated between 1997 and 2000. While it is not fully comparable to the estimates with the GDP by expenditure, it still provides insight into how the various industries evolve on a per capita basis before the 2000s. The main observations by industry are:

• The stronger GDP per capita in the pre-2000s period was the result of robust growth coming from both the goods-producing sector and the services sector.
• While slower GDP per capita growth since 2000 can be attributed to both the goods-producing sector and the services sector, this underperformance has been more important in the goods sector, especially in the post-2014 period.
• After a strong performance between 1997-2000, manufacturing activity per capita has persistently declined since 2000 and is now about 35% below its peak of 2000Q4. When looking at the manufacturing subsectors, this reduction in GDP per capita in manufacturing is broad-based.
• After a strong showing up to end-2014, the construction sector has been contracting on a per capita basis since 2014. The underlying details show that the decline has been mainly in engineering construction activity and non-residential building. On the residential side, activity held up until 2022, after which it declined significantly due to the impact of higher interest rates.
• Oil and gas extraction has had stronger performance post-2014 than in previous periods, as investment projects started pre-2014 entered their production phase.
• In the period since 2022, most industries have seen a decline in their per capita activity. Although this decline has been more important in the goods-producing sector, there is also a contraction in the service-producing sector activity per capita.

What is clear from these observations is that GDP per capita slowed in the 2000s and that the weaker growth was mostly in the post-2014 period. The composition of GDP per capita shows that the collapse of oil and gas investment was the main driver of lacklustre performance.

However, there is also clear evidence that non-energy sectors of the economy also had a mediocre performance in the 2000s. As such, we can note a broad-based decline in manufacturing activity per capita and non-energy exports.

Similarly, the contraction in most components of GDP per capita after the BoC started increasing interest rates in 2022 clearly supports our view that the Canadian economy was very likely in a recession over the period. However, because of strong population growth, aggregate economic activity did not contract, hiding the extent of the underlying weakness.

What explains Canada’s underperformance relative to the US?

In this step, we look at the drivers of the divergence between Canada’s performance and the US, by analyzing Canada’s GDP per capita relative to the US.

As mentioned previously, both countries had a very similar performance between 2000 and the end of 2014. Subsequently, persistent underperformance in Canada has meant that the US GDP per capita is currently about 15% higher than in Canada.

We take the analysis a step further by looking at which Canadian factors, using GDP by expenditure, explain the changes in relative GDP per capita between the US and Canada.

The results of this decomposition are very interesting and confirm many of the observations made previously.

• In the pre-2014 period, there were diverging factors to explain Canada’s performance relative to the US. On the upside, consumer spending, private fixed investment, and government spending were pushing GDP per capita in Canada to outperform that of the US. On the downside, constant underperformance in exports and imports (likely driven by strength in investment) was restraining GDP per capita in Canada.
• After 2014, the sectors that were outperforming the US started to weaken steadily. By 2019, all components, except for government spending, were pushing Canada to underperform relative to the US.
• The biggest turnaround was in private non-residential investment. In 2013, this sector pushed Canada’s GDP per capita to almost 3 percentage points higher than in the US. By the end of 2024, it was responsible for about 6 percentage points of the 15% Canadian underperformance relative to the US. This is a significant turnaround.
• The main contributor to the current divergence between Canada and the US is household spending, responsible for 9 percentage points of the 15% divergence. This sector was a small positive contributor in 2014 at about 3.5 percentage points. Looking at some of the drivers of this weakness, we find that Canada’s growth in real household disposable income during the oil investment boom was stronger than in the US. However, after the bust in 2014, it was persistently weaker.
• The bigger contribution from household spending to Canada’s underperformance relative to the contribution from non-residential investment is mainly the result of household spending representing a bigger share of GDP. Hence, for the same percentage decline, household spending always has a bigger impact on overall GDP per capita than non-residential investment. Nevertheless, it also shows that the fall in non-residential investment activity was substantial given its small weight in GDP.
• Government spending is the only component that is preventing the relative level of GDP per capita from widening further.

These observations once again suggest that most of the divergence in GDP per capita between the US and Canada can be explained by the drop in oil prices in late 2014 and the subsequent collapse in investment in the sector. However, it also shows that other sectors of the economy weakened in the post-boom period, especially household spending, due to the indirect impact of the bust.

Implications of these observations: the oil investment boom masked the mediocrity of other sectors of the Canadian economy

These detailed observations provide a comprehensive portrait of the performance of the Canadian economy over the past few decades. The picture is not pretty and many of the economic malaises currently afflicting the Canadian economy did not start a decade ago.

Here are some important observations:

1. The oil investment boom of the mid-2000s to mid-2010s had a substantial impact on the Canadian economy, boosting economic activity per capita and household disposable income per capita.
2. The oil investment boom also had significant spillovers to other sectors of the economy. The strong performance of household spending per capita during the boom years, supported by the outperformance in disposable income, is one example. Similarly, the better performance of machinery manufacturing pre-2014 vs post-2014 is another example.
3. The weak performance of exports per capita since the start of the 2000s should concern an exporting nation such as Canada. It suggests that the export sector did not contribute to raising Canada’s living standards for the past 25 years. This is a sharp departure from its importance in wealth creation since the early 1960s.
4. Within the export sector, it is also important to note that energy exports per capita saw significant growth over the period, while non-energy exports have been the main source of drag on overall exports per capita. Again, this is further evidence of weakness in the non-energy sector.
5. The manufacturing sector has been a constant drag on GDP per capita since the early 2000s. This suggests some important struggles within the sector and likely explains why non-energy exports have underperformed since the 2000s.
6. Since the oil investment bust, continued weak performance of the rest of the economy, especially non-energy exports and manufacturing, meant that the Canadian economy was left with no economic sector able to drive Canada’s economic prosperity.

In summary, it is clear that the investment boom in the oil and gas sector from mid-2000s to mid 2010s obscured the mediocre performance of the rest of the Canadian economy, particularly in manufacturing.

What does it mean for Canada’s future prosperity and future research?

The important questions that will need to be answered going forward are: can this situation change? Which sectors will drive Canada’s prosperity in the future? To answer these questions, two important points need to be understood. These will be the subject of two upcoming reports:

1. Why has oil and gas investment remained subdued in recent years despite relatively favourable oil price levels? Our preliminary work suggests that the lack of rebound in oil and gas investment in the late 2010s and 2020s is not unique to Canada. Globally, oil and gas companies are returning a greater share of their revenues to shareholders rather than investing in their operations. This is important, as it suggests that oil companies are not investing due to a global shift in shareholders’ preferences. This trend also suggests that Canadian regulations, although arguably unhelpful, may not be the primary reason for the sector’s lack of investment and its impact on the economy (see Where’s the boom? How the impact of oil on Alberta may have permanently weakened and Where’s the boom? And the rise and fall of the Alberta Advantage).

2. What explains the mediocre performance of the rest of the Canadian economy, particularly non-energy exports and the manufacturing sector? A lack of competitiveness is likely the main culprit. As we have shown (see Canada’s housing obsession is cannibalizing productivity), chronic underspending on productive investment over multiple decades is the cause for the weak productivity performance in Canada. More importantly, there is evidence that the household borrowing over the past 30 years has crowded out business investment.

This divergence between resource and non-resource sectors during a commodity boom, with a sharp improvement in Canada’s terms-of-trade and a significant appreciation of the Canadian dollar, suggests that the Canadian economy may have been affected by “Dutch Disease”. However, our preliminary analysis suggests that globalization may have played a much bigger role in the underperformance of the manufacturing sector. 

Conclusion

Canada’s current poor economic performance did not start in 2015 when its divergence from other major economies became noticeable. Instead, when examining the drivers of Canada’s underperformance, it is clear that the non-energy sector has exhibited a mediocre performance since the early 2000s. However, because of the boom in energy-related investment, headline economic activity remained acceptable. The collapse of the energy investment following the drop in oil prices in late 2014 only made the situation more evident.

To solve Canada’s economic problems, policymakers must consider how to make the non-energy sector competitive again. This will likely involve ensuring businesses have the incentives and the resources to spend on productive investment and enhance their competitiveness.

In the energy sector, policymakers will need to understand that weak investment is likely due to global factors. While Canadian regulations enacted over the past decade have been unhelpful and have also impacted other sectors from mining to infrastructure investment, they are not the only reason for the lack of rebound in oil and gas investment in recent years. Policymakers also need to consider these facts, as they suggest that eliminating regulations may not provide the boom in investment and the economic prosperity that is hoped for.

 

 

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Independent Opinion

The views and opinions expressed in this publication are solely and independently those of the author and do not necessarily reflect the views and opinions of any organization or person in any way affiliated with the author including, without limitation, any current or past employers of the author. While reasonable effort was taken to ensure the information and analysis in this publication is accurate, it has been prepared solely for general informational purposes. There are no warranties or representations being provided with respect to the accuracy and completeness of the content in this publication. Nothing in this publication should be construed as providing professional advice on the matters discussed. The author does not assume any liability arising from any form of reliance on this publication.