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Country Profile Series Canada In-depth PESTLE insights PESTLE Country Analysis Report: Canada ML00002-006/Published 11/2014 REFERENCE CODE: ML00002-006 © MarketLine. This report is a licensed product and is not to be photocopied Page 1 PUBLICATION DATE: November 2014 WWW.MARKETLINE.COM MARKETLINE. THIS PROFILE IS A LICENSED PRODUCT AND IS NOT TO BE PHOTOCOPIED OVERVIEW Catalyst This profile analyzes the political, economic, social, technological, legal and environmental (PESTLE) structure in Canada. Each of the PESTLE factors is explored on four parameters: current strengths, current challenges, future prospects and future risks. Summary Key findings Canada has a strong democratic setup, but tensions between federal and provincial government undermines effective governance In Canada, democratic principles have been predominant since the late 19th century, when the provinces were self- governed. After World War II, either the Conservatives or the Liberals have ruled the country. Canada ranked in the 95.26 percentile on voice and accountability parameter and in the 94.79 percentile on rule of law parameter in 2013 World Bank Worldwide Governance Indicators, indicating the stability of the democratic system. Canada has a loose federal structure, and the provincial governments are given independent legislative powers in local matters. However, this sometimes leads to conflicts of interest between central government and the provinces. The loose federal structure can create situations where there are clashes of interests between the federal and provincial governments. Canada's sound banking sector has kept the economy on a firm footing, but high household debt is a risk The World Economic Forum (WEF) has ranked Canada's banking sector as the most sound in the world for seven years in a row from 2008-14 and has lauded the sector for its adequate capitalization and efficient regulation. In March 2013, the federal financial regulator, the Office of the Superintendent of Financial Institutions (OSFI), ordered the top six Canadian banks, considered systemically important, to maintain a common equity tier 1 capital (a financial indicator measuring core equity capital as a proportion of total risk-weighted assets) of 8% against 7% for other financial institutions from January 2016 onwards. The fact that all the six banks meet these requirements adequately as of July 2014 is a reflection of the sector's strength. Moreover, the OSFI also adopted the Basel III leverage standard of 3%, which is a more accurate measure of banking sector strength as it also takes into account off-balance sheet exposures. However, high household debt levels in Canada represent a major vulnerability for the economy. According to Statistics Canada, the country's household debt, which began an uptrend in the mid-1980s, was at 163.6% of GDP in July 2014. Much of this appreciation had been driven by Canadian population's propensity to buy homes, which again stems from record-low mortgage rates in the country. The Canadian housing market has appreciated sharply since the beginning of the last decade, growing by 87% since 2000. Moreover, it experienced an increase in household prices even after the 2008 financial crisis, unlike the US, where housing prices collapsed. Subsequently, price-income and price-rent ratios in Canada are among the highest among developed nations. Despite increasing housing costs, the level of investment in households has continued to increase and has outpaced its pre-crisis peak on the back of low interest rates and loose credit conditions, and household debt to GDP has surged to new highs. Canada does well in human development, but aging population could strain public finances in future Canada has performed well on various social parameters. According to the UNDP's Human Development Report 2014, PESTLE Country Analysis Report: Canada ML00002-006/Published 11/2014 © MarketLine. This report is a licensed product and is not to be photocopied Page 2 the country was ranked 9th out of 187 countries with a HDI value of 0.902. According to CIA - The World Factbook, as of 2014, life expectancy for the male population was 79.1 years, whereas for females it was 84.4 years. All in all, Canada has performed quite well in terms of HDI. Like most developed economies, Canada is facing the problem of aging population. This is evident from the whopping increase in the number of seniors and a drastic fall in the young population over the last few years. The median age of the country is 41.5 years in 2013, which indicates that half of the population is above this age. The population belonging to the baby boomer generation is growing older, with many of its members nearing (or already having reached) retirement. According to the OECD, the dependency rate of the Canadian population will also increase. The long-term forecasts by the OECD estimate that seniors will account for 47.7% of the working age population (20-64) in 2050 against just 22.5% in 2010. Despite the rollout of some of the most generous tax incentives, business R&D expenditure in Canada remains low Canadian R&D tax incentives for business innovation are among the most generous in the world. The B index measures the before-tax income needed by a firm to break even on $1 of R&D outlays. The 1 minus the B index shows the government's focus on R&D, especially for small and medium enterprises. In fact, the incentives given by Canada are much above even the US. Giving impetus to R&D is important for the Canadian economy to raise its productivity and living standards and the government rightly provides high subsidies to R&D activity. This could be helpful in the long run, as companies will find it more attractive to invest in innovation. However, Canada lags behind other nations in terms of R&D spending. Canada's total expenditure on R&D as a percentage of GDP—also known as R&D intensity—stood at around 1.8% in 2011, lower than the 2.1% in 2004. The major reason for this decline in R&D intensity has been a weak trend of business spending on R&D since 2000. Canada's flexible business environment attracts foreign investors, but restrictions in foreign ownership in some sectors may prove a deterrent Canada has a comprehensive legal and regulatory framework that provides transparency to the business environment. The regulatory processes are favorable for foreign investors, with national laws providing freedom to start, operate and close a business. Starting a business in Canada is far easier than in other nations, as it takes an average of five days and one procedure, compared to the OECD average of 9.2 days and approximately five procedures according to the World Bank's Doing Business 2015 report. The procedures needed to set up an enterprise are less cumbersome and more transparent. Canada's system for registering a business has been entirely online since 2006, and there is no need for minimum capital to set up a business. These factors make Canada a favorable destination for foreign investment. Despite Canada being an advanced nation, the government's restrictions on foreign ownership in sectors such as telecom, radio and broadcasting, and aviation still exist. Moreover, it is one of the few developed countries that have an investment review process. While Canada maintains a 46.7% FDI limit for domestic telecom services providers, foreign ownership of Canadian air carriers is limited to 25% of voting equity. Nevertheless, Canada amended its Telecommunications Act in mid-2012 allowing foreign ownership of telecom carriers with less than 10% market share by revenue to increase competition in the sector. Telecom carriers are permitted to continue operations even if their market share grows beyond 10% provided the increase is not an outcome of an acquisition or a merger with another domestic carrier. Nonetheless, the results of the 2014 spectrum auction, where three major domestic telecom players (Bell, Telus and Rogers) acquired the majority of licenses, show that further liberalization in the sector is desired. Other industries in which foreign investment is restricted include oil and gas, farming, book publishing and selling, fisheries, liquor sales, mining, collection agencies, engineering, optometry, pharmacies and securities dealers. There will be a rise in investment activities if these sectors are fully liberalized PESTLE Country Analysis Report: Canada ML00002-006/Published 11/2014 © MarketLine. This report is a licensed product and is not to be photocopied Page 3 Canada has comprehensive environmental policies, but its poor environmental record remains a concern The Canadian government has established mechanisms to meet the environmental challenges that come with economic development. The focus of environmental policies has broadened from local and regional issues to challenges of a global nature. Climate change, global biodiversity, ozone layer depletion, and the transportation of chemicals and hazardous waste are some of the areas that have appeared at the top of the country's environmental agenda. The country has made some progress in meeting its domestic environmental objectives and international commitments. Some advances have also been made in cutting air pollution, and policies have been created to reduce greenhouse gas emissions. However, the country performs poorly in many environmental indicators including sewage treatment, species at risk, greenhouse gas emissions, pesticide use and nuclear waste. According to Environmental Performance Index 2014 published by the Yale University, the country ranks 104th out of 178 countries in conservation of forest. Additionally, per capita emissions per unit of GDP are one of the highest among the OECD countries, which suggests inefficiencies in the consumption of energy. At the same time, Canada is heavily reliant on non-renewable energy resources, which is an important factor for the economic growth of the country.