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Carney and Mulcair going Dutch? Thoughts on the Bank of Canada Governor’s and “Dutch Disease”

Bank of Canada Governor Mark Carney recently delivered a widely-publicized major speech in Calgary on the economic phenomenon known as the “Dutch Disease.” This was more nuanced than much of the media coverage.

Governor Carney argued that the booming energy and wider resource sector concentrated in Western Canada has provided a significant boost to the national economy, creating jobs in the rest of the country in both manufacturing and services. Overall, he said, high resource prices have been a plus for Canada.

However, the Governor recognized that rising resource prices have been the major factor behind the rise of the Canadian dollar against the US dollar. And he further recognized that our manufacturing sector has been very badly squeezed by the high Canadian dollar which makes our exports much more expensive in the United States and other countries, and also makes imports from the US and China much cheaper in our domestic market.

Carney noted that the decline of manufacturing is taking place in all advanced industrial countries. However, Canada’s manufacturing sector has been in a flat-out nosedive. Since 2002, manufacturing as a percent of GDP shrank from 17% to just 11% -- a much more severe contraction than that of most other advanced industrial countries.

Chart 5 in the speech shows that we started a bit above the OECD average in 2002, and are now, at 11% of GDP, significantly below the average of 14% which has slipped only slightly over the same ten year period.

The manufacturing sector’s share of all Canadian jobs has plunged over the same decade, from 15% to 10% -- that’s about 500,000 jobs lost. On average, these jobs were more productive and significantly better-paid than the average job, and many were unionized.

Manufacturing is also important as a driver of higher-end service sector jobs. Considered old-fashioned by some, it still accounts for the majority of all business investment in research and development, and is crucially important to maintaining an innovative and highly productive modern economy.

While the resource sector has certainly created new jobs directly and in construction, the decline of the manufacturing sector is a key part of why our national employment rate remains about 2% lower than before the 2008 recession. Unemployment rates remain high in hard-hit industrial Ontario (8.0%) and Quebec (7.6%) – which together are home to over 60% of the Canadian labour force.

Just as job losses have not been offset by job gains, the decline of manufactured exports has not been matched by a rise in resource exports. In fact, since the early 2000s, Canada’s 2% current account surplus with the rest of the world of has turned into a large deficit of about 3%.

That means that, notwithstanding our booming oil and mineral exports, we are borrowing from the rest of the world to pay for our imports. A big trade deficit is a drag on growth and means that we are effectively exporting jobs.

It is something of a mystery why the Canadian dollar rose so dramatically against the US dollar when our trade position has been sharply deteriorating, and when our dollar is clearly over-valued in terms of its purchasing power.

A big part of the answer is that ‘hot money’ has flowed from other countries to Canada in search of higher interest rates than in the US, and in the hope that the Canadian dollar will continue to rise.

Governor Carney says that, even if the high dollar were cause for concern, there is little that can be done about it. This is debatable.

Canadian interest rates are indeed low, but not as low as in the US. The Bank of Canada could lower rates at a time when they themselves recognize that our economy is operating below capacity. Other central banks, such as that of Switzerland, have recently intervened in the foreign exchange market to bring down their own over-valued currencies.

Canadian governments could adopt policies which would limit the damage of the high dollar. Tax measures, such as a Tobin tax on short-term Canadian dollar trading, could potentially limit short-term speculative flows.

Another way to limit “Dutch Disease” would be for the resource-rich provinces to invest part of their resource wealth in foreign assets. That is what Norway has done to cushion its domestic economy against the impacts of a booming offshore oil industry, and similar to what Alberta did under Premier Lougheed with its Heritage Fund.

The OECD has recommended that Canada should create a sovereign wealth fund for natural resource revenues and invest in foreign assets to limit the effects of Dutch disease, while saving for future generations.

In his speech, Governor Carney pointed to more modest but nonetheless important measures to deal with the manufacturing crisis, such as building stronger linkages between our manufacturing and service sectors and the resource economy, and adding more value to resources before they are exported. He cited, for example, the potential to add Canadian refining capacity.

The problem of “Dutch Disease” is real, and we should seriously consider the solutions at hand.

Andrew Jackson is the Senior Policy Advisor at the Broadbent Institute.

Photograph by Todd Korol, Reuters