Spare capacity allows economies to grow without creating inflationary pressures. And one of the reassuring things about the current situation as compared to 1994-95 has been the belief that Canada and much of the world have spare capacity, so the inflation genie should stay bottled up.
But the latest numbers show that Canada’s capacity utilization rose strongly in the past six months, to 83.5 per cent. This is about the same as it was in 1994-95, when Canada’s interest rates rose from four per cent to eight per cent to keep inflation pressures contained. Should we be worried?
First, a bit of history. Canada’s capacity utilization hit a peak of 87 per cent back in 1987-88, a time when inflation pressures were a real concern. The recession of 1990-91 pushed utilization down to 77 per cent. During the subsequent recovery period there was a gradual rise in utilization, but then it surged to nearly 84 per cent in 1994. Higher interest rates caused a moderation in 1995-96, to 81 per cent, and the subsequent recovery led to a peak in 1999 of just over 85 per cent.
All this to say that the recent rise to 83.5 per cent has taken us back into the yellow-light zone, where inflationary pressures may, in theory at least, be lurking just beneath the surface. However, the situation differs greatly across industrial sectors. Capacity utilization in mining is about the same today as in 1994, at around 86 per cent. Overall utilization in manufacturing is also about the same – and this may be said for a range of manufacturing sub-sectors, including processed foods, printing, chemicals, rubber, primary and fabricated metals and transportation equipment. But there are many sectors that are busier today than they were in 1994, and many that are less so.
The busier sectors where utilization today is significantly higher than in 1994-95 include wood products (97 per cent today versus 92 per cent in 1994-95), construction (87 versus 80), and forestry and logging (92 versus 81). Undoubtedly, these high levels of activity reflect North America’s ongoing housing boom. Other busy sectors: petroleum and coal products (97 per cent versus 93 per cent), plastics (89 versus 84), and non-metallic mineral products, which is at 92 per cent today, versus only 81 per cent back in 1994-95. These sectors are riding the global commodity boom.
And where are the soft spots? Comparing capacity utilization rates of 10 years ago to those of today, we have big declines in Canadian capacity utilization in the oil and gas extraction sector (64 per cent today versus 84 per cent in 1994-95), textiles (73 per cent versus 86 per cent), clothing (74 versus 83), leather (65 versus 82) and tobacco products (65 versus 84). Other stressed sectors include beverages (76 versus 84), electrical equipment (74 versus 84), machinery (80 versus 87), computers and electronics (76 versus 88), furniture (76 versus 81) and paper (90 versus 96). These sectors are feeling the strongest competitive pressures from foreign producers, compounded by last year’s appreciation of the Canadian dollar.
The bottom line? Canada’s overall capacity utilization has hit the yellow zone, where central banks begin to monitor inflation pressures carefully.
Yet there are many segments of the economy where there remains excess capacity – which should help keep inflation in check.
(Stephen Poloz is vice-president and chief Economist for Export Development Canada. He can be reached at spoloz@edc.ca)
