Surprise: Manufacturing survives high dollar and Dutch Disease is a false diagnosis, study finds
High commodity prices do not account for all of Canadian dollar strength. Manufacturing resuming lead role in post-recession growth.
OTTAWA, January 16, 2013 – 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.
These are key findings in a Macdonald-Laurier Institute (MLI) study released today.
Conducted by Philip Cross, MLI’s Research Coordinator, the study found that reports of the Canadian manufacturing sector’s impending death are greatly exaggerated.
“They (manufacturers) have resumed their leadership role in growth during the recovery, and are poised to lead Canada in the years to come as key markets in the U.S. auto and housing sectors return to more normal levels of demand,” says Cross, former chief economic analyst for Statistics Canada.
Rising commodity exports and the strengthened Canadian dollar of the past decade have prompted some to worry that the economy has contracted so-called Dutch Disease, in which a rising currency driven by high commodity prices a country’s manufactured goods out of world markets.
But that diagnosis is just not backed up by Canadian economic growth numbers, Mr. Cross concludes.
“Instead of lagging, the volume of manufacturing output rose 12.2% from the second quarter of 2009 to the third quarter of 2012,” he says.
It may be true that three manufacturing sectors – auto, forestry and textiles – were adversely affected by a plunge in U.S. growth for the first two groups and emergence of China as a textile producer in the case of third.
But other manufacturing sectors such as machinery – with output soaring 44% between the second quarter of 2009 and the third quarter of 2012 – are thriving, while the auto industry has been recovering strongly.
“If manufacturers in Canada suffered from Dutch Disease after 2002, it was a very mild case affecting only a small number of industries,” Mr. Cross says.
Manufacturers adapted to the higher exchange rate by reducing their reliance on exports and increasing their use of imported inputs. Imported goods are cheaper when paid for with high Canadian dollars and that has acted as a hedge against the currency making our goods costlier in export markets.
Mr. Cross also looked at another common belief – that our high currency is a byproduct of high commodity prices. It actually isn’t.
He believes “Bay St. Buck” rather than petro-dollar is a more accurate description.
The strength of the Canadian dollar can be attributed to prolonged weakness of the U.S. counterpart and inflows of capital by foreign investors attracted to Canada’s stable banking system and a safe haven of Canadian bonds.
“Since the financial crisis began in 2007, foreign investors increased their holdings of Canadian bonds by $274.4 billion by the end of 2012,” Mr. Cross says.
“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.”
As for the term, Dutch Disease, even that is a misnomer. It was coined after the discovery of offshore natural gas fields in the Netherlands in 1959. The theory was that the macroeconomic impact would choke Dutch manufacturers out of export products.
Although this theory has been long remembered, the data supporting it was short-lived, Mr. Cross notes. “Dutch manufacturers quickly recouped whatever ground was lost after the initial surge in the exchange rate.”
The Macdonald-Laurier Institute is an independent non-partisan Ottawa-based national think tank devoted to the development of Canadian public policy.
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