By: Michael Holden
Over the past few weeks, countless articles have been written about the question of whether or not Canada is suffering from Dutch Disease—an economic affliction by which large-scale development and export of natural resources drives up the value of the domestic currency and thus erodes the international competitiveness of the country’s manufacturing sector.
The issue first captured public attention during a brief but public spat between Alberta Premier Alison Redford and Ontario Premier Dalton McGuinty, but began to dominate headlines when NDP leader Thomas Mulcair took up the cause. The ensuing debate has been regionally divisive and largely unproductive. To the extent that it implies that growth in one part of Canada is coming at the expense of prosperity elsewhere, it is a recipe for disaster from a nation-building standpoint.
Is Canada a victim of Dutch Disease? While there is some debate on the matter, a number of recent studies suggest that there is at least some evidence to support the idea. But a review of the data shows that, even if oil sands activity is driving up the dollar and harming the export competitiveness of eastern manufacturers, it is only a small part of the problem.
To begin with, there should be no doubt that much of the Dutch Disease story rings true in Canada. Thanks to booming oil production and exports, the Canadian dollar has become, at least in part, a petro-currency. As Figure 1 shows, the Canada-US exchange rate began in the early 2000s to mirror movements in international oil prices. This is not to suggest that the price of oil is the only factor that influences the dollar, or that the same effect can be seen versus other currencies. Nevertheless, a clear relationship now exists between oil prices and the Canada-US exchange rate.
Similarly, there is also a clear relationship between the Canadian dollar and the relative health of the manufacturing sector in Ontario (Figure 2). Since the late 1970s, employment in manufacturing has tended to move in the opposite direction of the loonie. This trend is a natural result of Ontario’s heavy dependence on the US market. When the dollar goes up, manufactured goods from Ontario (and elsewhere in Canada) become more expensive in the US, so demand for those products falls and manufacturing activity north of the border slows as a result. When the dollar weakens, Canadian goods become relatively cheap, US demand for them increases and production activity increases. It is no coincidence that Ontario’s peak levels of employment in manufacturing were in the early 2000s, when the dollar was at historic lows.
But is that all there is to it? Are Ontario’s manufacturing woes the result of oil sands activity and is a lower dollar the solution to the problem?
To answer these questions, it is instructive to compare the performance of manufacturing in Canada with that of the US. Using 1990 as a starting point, Figure 3 shows that, at least from an employment perspective, Canada has outperformed the US over the past 20-plus years. Of course, the term “outperformed” is essentially damning with faint praise. In April 2012, Canadian employment in manufacturing was about 13% below 1990 levels while in the US it was nearly 33% lower.
Looking at such a long time horizon captures long-term trends, but it also glosses over the run-up in the Canadian dollar in recent years. From 2002 to 2011, the dollar rose from an average of 63.7 cents US to US$1.01. How did manufacturing employment in Canada and the US compare over that period? As it turns out, they were almost identical; employment levels in both countries dropped by 23%.
In other words, even though the Canadian dollar rose by 59% in nine years, the US manufacturing sector performed just as badly (in terms of employment levels) as the Canadian sector over that period.
Why? The reasons are complex and varied, but the two most obvious contributors are low-cost competition from China, Vietnam, Indonesia and other Asian markets; and the impact of the global financial and economic crisis. The former has been eroding the manufacturing base in North America, while the latter has undercut domestic demand for the goods produced here. The solutions to these challenges are not easy, but most agree that they are found in innovation, productivity gains and a rebound in consumer confidence.
Oil sands activity and high oil prices have undoubtedly contributed to a higher Canadian dollar. And this hasn’t made life any easier for Ontario manufacturers. But the dollar is clearly not the main problem and treating national economic activity as a zero-sum game, where growth in one region must come at the expense of growth in another, is not the solution.