Canada goes the cost reduction way

Canada had its general elections last Monday and while the winner, the actual Prime Minister Stephen Harper from the Conservative Party, was totally expected; the result boosted him to a majority government. With their hands untied from a minority government against the New Democratic Party, Mr Harper's Conservatives are now free to apply the keystone point in their electoral program, taxes and government spending reductions.

Stephen Harper celebrating victory

I have expressed my concerns on excessive government spending worldwide on previous posts, Canada was not an exception there, with 39.7% of GDP going to government expenses every year... Canadians have expressed their concerns with the matter too, strongly supporting the only party that promised to reduce said spending. With this move, Canada joins the trend of slashing government spending, a trend that started in Europe to fight troubled economies like Greece's, but that has gone mainstream since then on developed economies. Finally everybody begins to notice the weight of the state is unbearable as of now, recession has made this blatantly visible.

I will not analyze in detail the politics behind Mr Harper's party, but from a macroeconomic point of view Canada is in a far better position to boost recovery than for example European countries. Canada is one of the few net energy exporters (together with Norway) among developed countries and is also the world's second biggest uranium producer with 20.7% of production. Not only they are exporting energy abroad (which at actual prices is quite a good business) but they are energetically independent as they control the supply for their main energy source, nuclear energy.

This independence means their recovery plans will not be heavily altered by raising energy prices, or tensions in the Middle East for that matter... If the Conservative's deficit reduction plan works as planned and corporate tax reductions really help boost employment I would say it is quite possible for them to be able to beat IMF's expected GDP growth of 2.8% for 2011. I am confident on every economy that successfully covers its energy needs and Canada has been doing it for a long time.

Energetic independence partly shields Canada from the never-ending commodities rally and thus gives it the most desirable ground for economic recovery and growth: a ground where it can focus on its own economic efficiency.

Oil prices shape the present and the future of the economy

Modern economies are oil-junkies, and they will still be for a long time. Every movement in the price of oil, no matter how small, reaches the furthermost endpoint of the economy. Without hesitation I can say that oil price is the key factor shaping (and limiting) the behavior of our day-to-day economy. An even more important factor than interest rates or currency exchange rates, which are predominant in the long term.

Actual oil prices are the result of a deadly combination of circumstances: political instabilities in oil producer countries, a low exchange rate of the US dollar (still the preferred currency when trading oil), rise on total demand due to developing economies and last but not least speculation. The extended duration of this situation is very worrying for both oil consumers and oil producers. Consumers, meaning developed and developing economies as a whole, have their GDP growths strongly linked to oil prices, as it has the power to increase the cost of production and distribution processes and also personal transport expenses; all of them key drivers for a healthy economy.

On the other side, oil producers fear that high oil prices can harm demand. Even though oil demand has historically been highly inflexible, as energy is a primary need, it also has its breaking point. This breaking point is that where more expensive energy sources (think alternative energies) become affordable when compared with oil.
Oil producers are aware of this breaking point and on the last days we have seen reactions from Saudi Arabia and Kuwait, biggest and 7h biggest oil exporters worldwide respectively, saying they do not endorse such insanely high oil prices. They are profiting largely from these high prices, but at the same time they show some much needed common sense by acknowledging high oil prices can brake or break economic growth. They need their clients' economies to grow, to need more and more of their precious oil.

The government, that drag on the economy.

In the previous post, on why economic recovery was being compromised by excessive and useless government spending I quickly illustrated my point with a table showcasing government expenditure in percentage of GDP and also average tax burden on percentage of GDP. I did not analyze the data from the table though, it deserved its own post. So let us have a look at how much money the governments need in some countries:

2011 data from The Heritage Foundation , The Wall Street Journal via Wikipedia

The highest percentages on government spending are found scattered across developed countries, specially in Europe. On Baltic countries (Denmark, Finland, Iceland, Norway and Sweden) we can see the percentage even goes over 50% of GDP . No surprises here, blame it on their splendid welfare systems everybody loves... The real problem is not welfare systems themselves, but the progression of the government spending in the latest years. People would agree with me than welfare systems and social measures have not increased during the last 5 years, in any case they have been reduced, but government expenditure on the other side has kept growing, as plotted in the following chart for the biggest economies in Europe.

Credit: Eurostat

The corrections on the growing trend seen in the 2010 data, as you may expect, are related to the austerity packages endorsed by the European Union to fight the financial and debt crisis. But these corrections have been too soft to correct the situation. Economists and traders everywhere (The Economist devoted an issue to this matter) see the situation as unbearable, which explains the rising concerns on sovereign solvency that has plagued the markets and has already blasted through Greece, Ireland and Portugal.

But if this has been this way for a long time, what can possibly have changed to make the situation so worrying for developed countries?