A Growing Chill For Canada

Growth is faltering. Will Canadians lose their social perks?

As a high school guidance counselor, Joe Santalucia usually exudes optimism. Not these days. Locked out of his Toronto school from Sept. 8 to Sept. 28 in a province-wide dispute over budget cuts and working hours, he sees less security and leaner times looming. "The government is trying to balance the books, so when we go to the hospital, we have to wait five hours," says Santalucia, 42. "Education is suffering. We will have to live with less and less."

Across Canada, the good life is in jeopardy, threatened by a mix of government spending cuts, gloomy economic forecasts, and the deepening global crisis. Signs of trouble abound. Interest rates are up in an effort to bolster the Canadian dollar, now scraping along at historic lows against the U.S. dollar (chart, page 162). Labor peace has collapsed amid strikes by teachers, airline pilots, mill workers, and even doctors. The jobless rate, which has been slowly falling from its 1992 peak of 11%, is expected to stall at more than 8% next year. "The economy is fragile," says John Lester, chief economist for brokers CIBC Wood Gundy Inc. "It is on a mediocre growth path and really very vulnerable."

That's a sharp turnaround from just over a year ago. Then, Canada's outlook was brighter than the Northern Lights as it got a big lift from booming U.S. and Asian economies. With gross domestic product barreling toward a nearly 4% rise in 1997, Canada set the pace among the Group of Seven industrial powers. Today, it is burdened with unsolved problems: huge debt, high taxes, and a costly government role. And as the Asian crisis spotlights national weaknesses, investors are treating Canada like an emerging market. Their wariness is reflected in risk premiums of 49 to 60 basis points that Canada is having to pay on its Treasury borrowings over comparable U.S. Treasury bills.

Certainly, the Canada that emerges a couple of years from now will be markedly different--and many Canadians won't like it. Already, stalwarts such as forest-products giant MacMillan Bloedel Ltd. have cut staff to contend with low commodity prices. A slowdown could force restructuring on a broad range of manufacturers. And government will have to scale back even further. Says Joshua Mendelsohn, chief economist at Canadian Imperial Bank of Commerce: "The Canadian public will have to accept a somewhat leaner system that doesn't cater to every whim."

For two generations, Canadians have been growing accustomed to a comfortable welfare state with benefits from fully paid health care to heavily subsidized education through graduate school. As recently as 1991, government spending accounted for more than half of the country's GDP--but at a high price. Canada piled up a $349 billion net debt, the industrial world's biggest after Italy as a percentage of GDP.

Recognizing that Canada was living beyond its means, the Liberal government reined in spending in 1994 and balanced the budget in the last fiscal year. Cuts in social programs have sparked protests, ranging from teachers in Ontario to doctors in western Canada. Even though economists predict a meager GDP gain of little more than 2% next year, the federal government vows to hang tough. "We are not going back into deficit," vows Finance Minister Paul Martin. "This country is in the black, and it is going to stay there."

While the government keeps the brakes on spending, the Canadian economy is being hurt by commodity deflation as a result of the Asia crisis. Canada remains the G-7 nation most dependent on natural resources, from nickel to tar sands. Falling prices are hammering the sector, which accounts for 10% of GDP and 35% of merchandise exports. No wonder Canada's stock markets are making hard-pressed U.S. markets look like oases of calm. While the Dow Jones industrial average is off 16.6% from its July high, the Toronto Stock Exchange's 300-stock index is down 29.5% from its April peak.

Canadians recognize the risks of relying on commodities. "They are not going to provide us with the standard of living we need," says Jock A. Finlayson, an economist at the Business Council of British Columbia. Indeed, natural resources' share of exports is down by nearly one-half from what they claimed in 1980. Still, continuing dependence on commodities keeps Canada on an economic roller coaster. Forecasts of even 2% growth next year could prove optimistic, if other economies tank. "If we have more shocks to the system, all bets are off for everybody," warns Thomas d'Aquino, CEO of the Business Council on National Issues, a group of 150 top business leaders.

The sliding Canadian dollar poses another worry. Not only is it making imports more costly, but moves to shore it up have proved problematic. Anxious about the loonie's 12% plunge in 12 months, to just over 63 cents (U.S.) in late August, the Bank of Canada has spent billions propping it up and has raised interest rates repeatedly. Its biggest move, on Aug. 27, hiked the prime rate a full percentage point, to 7.5%, though a recent cut that mimicked the Federal Reserve has since pared the prime to 7.25%. Still, steep borrowing costs now threaten to choke off growth. "Another 100 basis points could kick the economy into recession," warns CIBC Wood Gundy economist Lester.

Canada wasn't always so vulnerable. The loonie fetched more than $1 in 1976 and was approaching parity in 1991. But since then, while noncommodity sectors have grown, the shift toward high tech hasn't been fast enough. Despite such telecom powerhouses as Northern Telecom Ltd. and Newbridge Networks Corp., Canada hasn't kept pace with hot-growth incubators like Silicon Valley. "There are 50 times more technology companies in the States," complains Newbridge Networks Chief Executive Terence H. Matthews.

Canada's difficulty in nurturing cutting-edge industries stems from policy mistakes. As politicians have crowed about Canada's more caring and compassionate society, they have boosted taxes steeply to pay for it. With even modest earners winding up near the 50% bracket in federal and provincial taxes, talent has looked south for more lucrative opportunities.

"NANNY STATE." But Canada has a long and burdensome legacy of Big Government. Years of overspending since the mid-1970s piled up net government debt that now equals an estimated 60% of GDP, far above the 46% level in the U.S. Even with the Liberal government's current penny-pinching, public outlays still account for nearly 42% of GDP, vs. less than 32% in the U.S. "We are still a nanny state, big-time," complains Fazil M. Mihlar, director of regulatory studies at Vancouver's Fraser Institute.

While the opposition Reform Party and business leaders call for lower taxes, no Canadian Ronald Reagan has arisen with a mandate for deep cuts. Liberal Prime Minister Jean Chretien has suggested that the next federal budget may pare taxes, but he is shunning radical steps such as privatizing health care--a move that would violate Canadians' mildly socialist mind-set. "Those are very enduring values that are pretty deeply embedded in the Canadian way of thinking," says Ralph Goodale, Liberal minister of natural resources.

Nevertheless, such values may be fast growing obsolete and unaffordable. If hard times spread, the government will be pressed to retrench or change. Otherwise, its political prospects may collide with harsh economic forces. Either way, Canada's caring and compassionate society faces sore testing.

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