A mild case of ‘Dutch disease’; Canada’s waning competitiveness – not the high dollar – is the main cause of our manufacturing woes

Mohammad Shakeri, Richard S. Gray and Jeremy Leonard May 23rd, 2012
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As the war of words over the regional economic effects of Alberta’s oilsands that has pit West against East, a careful look at the evidence shows that the impact of the energy sector and the strong dollar on manufacturing is far less widespread and much more nuanced than conventional wisdom would suggest.

Natural resource wealth can be a double-edged sword. On the one hand, it contributes to strong economic growth and higher standards of living, relatively low unemployment and (until the recession) healthy public finances. These benefits are especially evident in the energy-rich provinces, but are in fact felt across the country. On the other hand, a booming resource sector can in some instances lead to unbalanced growth against other sectors of the economy.

Given that the resource boom has coincided with both a strengthening Canadian dollar and significant losses in manufacturing employment and output, it has been widely blamed for the woes in the manufacturing sector in Central Canada and cited as a text-book example of the so-called “Dutch disease,” which takes its name from the adverse effects the discovery of large natural gas fields off the coast had on the Dutch manufacturing sector in the 1970s.

But correlation does not imply causation, and in a recent study published by the Institute for Research on Public Policy, we examined trends in out-put 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. Our results indicate that only one-quarter of total manufacturing output in Canada has been adversely affected by the dollar’s increased strength.

Dutch disease most strongly affects small, labour-intensive industries such as textiles and apparel. Larger industries, such as food products and metals and machinery, are less adversely affected. To the extent that they are, the small negative impact of the strong dollar has been more than offset by strong growth in demand, such that output in those industries has continued to grow.

Contrary to popular belief, the high dollar is not the primary culprit behind the woes of the automotive sector. Rather, the sector’s weakness stems from cyclical changes in demand and increasing competition from firms with lower costs, such as South Korean-made cars which have become important competitors in Canadian and U.S. markets over the past 10 years. Trends in the auto sector are mirrored in many other industries, as import penetration from Asia and other emerging markets to the U.S. reaches into other industries traditionally served by Canadian exporters.

On balance, the evidence indicates that Canada suffers from a mild case of the Dutch disease. The more serious issue is the growing competitive pressures in both domestic and U.S. markets.

Because the main problem in manufacturing is not a rise in the exchange rate per se, but rather sluggish productivity growth and, in more recent years, a cyclical downtown in domes-tic and global demand, the policy response should stay focused on these core problems. For example, Ottawa could use additional federal tax revenues stemming from natural resource booms to invest in infrastructural and other projects that bring longlasting economic benefits and that bolster the competitiveness of the manufacturing sector as a whole.

In a report last year by the Premier’s Council for Economic Strategy in Alberta, a recommendation was made to create a “Shaping the Future Fund,” with the goals of insulating the provincial public purse from volatility in crude-oil prices and investing resource-revenue in innovation and the development of the non-resource economy. This report is on the right track by advocating investment of resource revenues in long-term economic sustainability rather than short-term spending and tax cuts.

The resource-rich provinces would 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 enjoyed by some regions does not become a curse for the country.


Mohammad Shakeri holds a PhD in economics from the University of Saskatchewan and Jeremy Leonard is a research director at the Institute for Research on Public Policy (IRPP). Richard S. Gray is a professor and acting head of the Department of Bioresource Policy, Business and Economics at the University of Saskatchewan. He currently leads the Canadian Agricultural Innovation and Regulation Network. They are co-authors of the new study, Dutch Disease or Failure to Compete? A Diagnosis of Canada’s Manufacturing Woes, published by the IRPP and available at www.irpp.org.