On January 16, the Macdonald-Laurier Institute published a study by former Statistics Canada analyst Philip Cross, entitled “Dutch Disease, Canadian Cure.” It argues that “after 10 years of a muscular dollar, Canadian manufacturers have adapted well to a strong currency – demonstrating that Dutch Disease is economic myth rather than reality.”
Mr. Cross argues, quite reasonably, that high commodity prices are not the only reason for the strong appreciation of the Canadian dollar after 2000. However, as Mark Carney noted in a recent speech, they are an important part of the story, explaining about one half of the exchange rate appreciation.
Far more contentious is Mr. Cross’s assertion that Canadian manufacturers are adjusting well to the higher exchange rate, especially outside of the hard-hit auto, forestry and clothing industries.
The overall statistics on manufacturing are undeniably grim. The number of manufacturing jobs in Canada fell by 464,000 from 2000 to 2011, and has only recently bottomed out. Manufacturing now accounts for just over 10 per cent of all jobs, down from 15 per cent in 2000.
Over the same period, manufacturing output fell by 14.1 per cent in real terms, and shrank from 18.1 per cent to 12.1 per cent of Canada’s GDP. Again, there has been a very modest recovery from mid 2011.
Mr. Cross argues that the overall figures disguise the fact that about half of the manufacturing sector has been expanding since 2002. However, on close examination, his figures in Table 1 show that almost half (46 per cent) of the increased sales of the “expanding” sectors came from petroleum, with much of the rest coming from basic processing of minerals and metals produced by the mining sector.
These numbers demonstrate the rather unsurprising fact that the resource boom has spilled over into resource processing, hardly contradicting the argument that the high dollar has squeezed higher value-added manufacturing. As he notes, strong demand from the resource sector has also benefited some Canadian machinery producers, though we remain large net importers in this sector. Even more contentiously, Mr. Cross argues that the steep decline in Canada’s manufactured exports is explained much more by weak demand in the U.S. market than by the high exchange rate, and that U.S. manufacturers were similarly impacted.
In fact, there has been a huge divergence in the fortunes of Canadian and U.S. manufacturers over the past decade. According to the U.S. Bureau of Labor Statistics, if 2002 is set as the base year, U.S. manufacturing output grew by 23.2 per cent by 2011, while shrinking by 11.5 per cent in Canada.
The same data base shows that Canada experienced a massive loss of cost competitiveness compared to U.S. manufacturers. Canadian unit labour costs rose by 79.1 per cent on a U.S. dollar basis from 2002 to 2011, compared to a fall of 14.3 per cent in the U.S.
Most of this huge loss in cost competitiveness was due to the appreciation of the exchange rate. However, lagging productivity is also an important part of the story. Between 2002 and 2011, hourly productivity in manufacturing grew by a stunning 55.7 per cent in the U.S. compared to an abysmal 10.6 per cent in Canada.
To summarize, U.S. manufacturing output and productivity have both grown strongly since 2002, while output has shrunk in Canada and productivity has barely improved.
This picture is not one of successful restructuring. Rather the dismal state of Canadian manufacturing is the result of an over-valued exchange rate combined with the impacts of a structural regression to relatively low value-added resource extraction and processing.
Canadian manufacturing may have bottomed out, but there is little to be satisfied about. Indeed, we need to be discussing how to deepen the weak linkages from the resource sector to the domestic capital goods sector, and how to add much more value to the raw materials that currently dominate our exports.
Andrew Jackson is the Broadbent Institute's Senior Policy Advisor. This article originally appeared in the Globe and Mail's Economy Lab.