May 16, 2012
Research program: Competitiveness, Productivity and Economic Growth
News release | Summary | Interview | Study | Podcast with FARE Talk
A mild case of 'Dutch disease'; Canada's waning competitiveness - not the high dollar - is the main cause of our manufacturing woesMohammad Shakeri and Jeremy Leonard
(Vancouver Sun, May 23, 2012)
The continuing global energy boom that began in the early 2000s has brought significant economic benefits to Canada in the form of strong growth in national income, relatively low unemployment and (until the recession) healthy public finances. These benefits are especially evident in the energy-rich provinces.
But a booming energy sector may contribute to a strengthening of the currency, which in turn cause lower and unbalanced growth in trade-intensive sectors (particularly manufacturing). This so-called ?Dutch disease,? which takes its name from the phenomenon observed in the Netherlands in the 1970s, has been widely blamed for the woes of the manufacturing sector, which is concentrated in central Canada.
There has been relatively little rigorous analysis of the linkages between energy prices, the exchange rate and manufacturing output in Canada. In this study, Mohammad Shakeri, Richard S. Gray and Jeremy Leonard examine these linkages for 80 different manufacturing industries using an empirical model that accounts for changes in global demand and competitive pressures as well as energy-induced strengthening of the dollar.
The results are more nuanced than conventional wisdom would suggest. Only 25 of the 80 industries (accounting for about one-quarter of total manufacturing output) show a significant negative relationship between the US-Canada exchange rate and output. The effects are most pronounced in small labour-intensive industries such as textiles and apparel. Larger industry groups such as food products, metals and machinery are much less adversely affected by the strong dollar, and these minor problems have generally been offset by strong growth in demand. Interestingly, automotive industries do not show symptoms of the Dutch disease; their weakness stems from cyclical changes in demand and lagging productivity growth.
On balance, the evidence indicates that Canada suffers from a mild case of the Dutch disease, which warrants a commensurate policy response. It is difficult to implement national policies to directly counteract the rising exchange rate (policies such as investing resource revenues in foreign assets, as Norway does), because resource revenues are under provincial jurisdiction. However, Ottawa can use additional federal tax revenues stemming from natural resource booms to invest in infrastructural and other activities that bolster the competitiveness of the manufacturing sector as a whole.
The resource-rich provinces would also be well advised to adopt policies to ensure that neither
public finances nor the economy becomes too dependent on natural resources, because history
has shown that prices and demand can fluctuate widely and suddenly. Avoiding such
dependence will help ensure that the resource blessing currently enjoyed by some regions
does not become a curse for the country.