Dutch Disease not a major Canadian issue, report says

The belief that the commodities boom of the past decade caused the decline in Canada's manufacturing sector is being challenged in a new report that also takes a swipe at the notion of the loonie as a petro-dollar.

The report, issued by the Macdonald-Laurier Institute and written by economist Philip Cross, argues that manufacturers' troubles stem more from structural economic changes than a higher Canadian dollar.

And it suggests that, in some ways, the commodities boom and its effect on the dollar actually helped the factory sector adapt.

For evidence, Cross notes that manufacturing output has grown the third fastest among 18 major industry groups since the 2008-09 recession, even outstripping growth in mining, oil and gas.

There is no question Canada's factory sector took a hit during the recession and that jobs have been disappearing over the past 10 years — upwards of 500,000 by some estimates.

But the report disputes that the higher Canadian dollar is a chief reason.

The three manufacturing specialties that took the biggest hit during the recession — autos, clothing and forestry — also contracted in the United States, the report points out. Therefore the reasons likely had to do with structural changes in specific markets rather than the exchange rate, it argues.

Greenback drop more of an issue

The report, being released Wednesday morning, also casts doubt on the relationship between commodity prices and the loonie.

It contends that the main reasons behind the decade-long appreciation of the Canadian dollar was not so much higher commodity prices, although they played a role, but the depreciation of the U.S. greenback and rising investment inflows into Canada.

Cross says rather than petro-dollar, the loonie can be more accurately called as the "Bay Street Buck."

"The recent strength of the exchange rate no longer can be attributed solely to commodity prices, and therefore resource prices cannot be singled out as the source of problems in Canada's manufacturing sector," says Cross, a former chief economic analyst with Statistics Canada.

"If manufacturers in Canada suffered from Dutch Disease after 2002 it was a mild case affecting only a small number of industries."

The theory behind Dutch Disease — a term coined to explain the hollowing out of the Dutch manufacturing sector — holds that a boom in the resource sector causes the currency to appreciate, undercutting exports of manufactured goods. It has some adherents among economists, including the Organization for Economic Co-operation and Development.

But it became a political football in Canada last winter when NDP leader Thomas Mulcair blamed Alberta's oil riches for the some of the economic problems facing Ontario and Quebec.

Carney dismissed theory

In a controversial speech in Calgary last fall, Bank of Canada governor Mark Carney largely dismissed the theory, saying that "higher commodity prices are unambiguously good for Canada," and that manufacturing's decline was part of a "broad, secular trend across the advanced world."

The Cross report acknowledges that the higher Canadian dollar — which continues to trade above parity — has squeezed profit margins for Canadian manufacturing exporters.

"But they have adapted to 10 years of a higher exchange rate and nearly five years of parity with the U.S. greenback by reducing their dependence on exports and increasing their use of imported inputs," the paper states.

"Manufacturers have by far the largest such 'natural hedge' against exchange rate movements of any industry."

Combining the two factors, the report calculates that manufacturing's dependence on the fluctuating exchange rate fell from a high of 27 per cent in 1999 to 18 per cent in 2008.

"The strategies of Canadian manufacturers to adapt to reality of a higher exchange rate have paid off," the report concludes. "Instead of lagging, the volume of manufacturing output rose 12.2 per cent from the second quarter of 2009 to the third quarter of 2012."

Only construction and wholesale trade have had higher growth rates over the period, it said.