The economies of Canada and the United States are closely intertwined, with trade between them amounting to $2 billion and 400,000 people crossing their shared border daily over a distance of 9,000 kilometers.

Canadians living on the west coast prefer to travel daily to nearby Seattle rather than the far-off Toronto.

It is not surprising that the economies of the two countries have moved in largely synchronized steps over the past few decades, as the U.S. GDP grew by 27% between 2009 and 2019, while the Canadian economy recorded a growth of 25% during the same period.

However, since the emergence of the COVID-19 pandemic, the gap has begun to widen between the two strongest economies in North America.

According to a report by The Economist magazine, by the end of 2024, the U.S. economy is expected to have expanded by 11% compared to what it was five years ago, while the Canadian economy is projected to record growth of no more than 6%.

The gap becomes even clearer when considering population growth, with the International Monetary Fund predicting that Canada’s per capita national income will reach 70% of its U.S. counterpart by 2025, compared to 80% before the pandemic, the lowest rate in decades.

If Canada’s ten provinces and three territories were a U.S. state, they would have shifted from just a slightly better position than Montana, the ninth poorest U.S. state, to worse than Alabama, the fourth poorest U.S. state.

Recession Dominates Canada

Although Canada avoided the worst consequences of the COVID-19 pandemic compared to the United States, which experienced a deep economic recession due to strict lockdown measures, Canadian economic performance did not maintain the same momentum.

In 2020, U.S. GDP fell by 5% compared to a decline of 4.2% in Canada.

While the Canadian economy recovered by 4% between 2021 and 2022, approaching the U.S. recovery rate of 5% during the same period, the gap between them began to widen again after 2022.

The reason behind this divergence is not merely a temporary setback but lies deep within the economic performance, as two key drivers of Canadian growth have faltered.

The first driver mainly depends on the services sector, which accounts for about 70% of the country’s GDP.

In the wake of the pandemic, Americans increased their spending on goods, positively impacting Canadian factories, which export about 40% of their output to the United States, but as Americans returned to focus on domestic spending in the services sector, demand for Canadian industries was affected.

Nathan Janzen from the Bank of Canada says, “The composition of growth in America has not been favorable to Canada,” leading the Canadian economy to rely more on the local services sector, which in turn depends on Canadian household and government spending.

Unfortunately, domestic demand in Canada has been pressured by rising interest rates, and inflation has been much higher in Canada due to greater interaction with inflation in the economy.

In Canada, mortgages come with a fixed interest rate for 30 years, making Canadians feel the effects of the increase more than Americans.

Moreover, a larger proportion of Canadians rely on fixed long-term mortgages, which has resulted in higher housing costs compared to the U.S.

In contrast, the Canadian government has focused on debt repayment, and the debt-to-GDP ratio increased by just one percentage point since 2019.

Unlike the United States, the Canadian government did not resort to increased spending to alleviate economic pressure; in 2023, the Canadian budget deficit was only 0.6% of GDP, compared to 6.3% in the United States.

The Oil Sector is Struggling

The other driver that has been stalled is the Canadian oil sector, which accounts for about 16% of Canadian exports.

After the collapse of oil prices in 2014, investments in the new oil sector declined, hurting the fuel-dependent economy.

In contrast, the United States benefited from lower prices, and when prices rose after the Russian-Ukrainian war, investors supported American oil producers, resulting in a significant increase in production.

In the first half of 2024, U.S. oil production increased by 25% compared to the same period six years ago, while Canadian oil production grew by only 11%.

With the diminishing importance of oil in the Canadian economy, it faced even greater struggles due to weak productivity in this vital sector.

The Productivity Problem

The issue of weak productivity has long been a chronic problem in Canada; over the last two decades, labor productivity growth has been slow, making Canada resemble Europe more than the United States, which greatly benefited from the technology revolution.

Since the pandemic, Canada’s per capita GDP has grown at a slower rate than any other G7 country except Germany.

While Canada had been compensating for weak productivity by increasing the number of workers thanks to high immigration rates, this has not been enough to close the widening gap.

Canada has seen the highest population growth rates since 1957, with immigration increasing unprecedentedly, but new immigrants have been less skilled than their predecessors, making them more vulnerable to unemployment or low-paying jobs, negatively impacting the country's economic outlook.

It is now clear that the divergence between the U.S. and Canadian economies began long before the pandemic, as Canada’s services continued to decline.

Although the Bank of Canada has cut interest rates three times this year, from 5% in May to 4.25%, many borrowers will feel the negative impact when renewing their mortgages.

Immigration restrictions have also been imposed, including capping the numbers of international students, but these measures will not solve the chronic productivity issue in Canada.

Thus, it seems that catching up with Alabama may become a distant dream.