Although it is painful for Canadians to admit, Canada does have a bad case of the Dutch Disease

The Painful Reality

During the 2015 Election, Thomas Mulcair, the NDP Leader noted that Canada had a case of Dutch Disease. That statement was roundly attacked in the Canadian political sphere, and undoubtedly contributed to the poor performance of the NDP during the election season in Western Canada. However, attacking the person for saying an unpleasant truth does not make that truth go away. It is sadly, a classic case of shooting the messenger. I disagree with Muclair on several other matters and feel that he has been an underwhelming NDP leader, but I’m forced to acknowledge that he is correct here.

For those that do not know, Dutch Disease is when a nation discovers a very wealthy source of natural resources and it crowds out the other sectors of the economy, such as agriculture, manufacturing, and technology. The term refers to how the discovery of the Groningen natural gas field helped contribute to the decline of Dutch manufacturing thereafter. What happens is that when the natural resources are discovered, there is a “crowding out effect”, where investment in other areas declines and people flood to enter the natural resources. The reason why is because there are often greater returns on investment (in the short run) and higher salaries caused by these natural resources. The problem is that due to the volatility of natural resource prices, there is also a huge downside when the prices go down because said nation has under-invested in all other areas of their economy and is thus, at a relative disadvantage compared to the rest of the world.  Another problem is that natural resources often overvalue said nation’s currency, leaving their non-resource exports even less competitive.

Worse, eventually the natural resources will deplete, as they are not infinite. Technological growth and productivity gains in the nation that has the natural resources is now behind the competition, due to many years of underinvestment. In many cases, said industries may have disappeared altogether, due to the “squeezing out” effect of natural resources.  The end result is that natural resources can often become a curse, as much as they are a blessing.

In 2014, Bank of Canada governor Stephen Poloz noted that in some areas, manufacturing output had fallen by as much as 75% since the year 2000. He estimated that this was a loss of approximately $30 billion dollars (2014 CAD$). Also, according to the Bank of Canada’s 2014 report here, exports remain weak, in part due to a weakened global economy. The report did note that some exports are gaining traction, but slower than historical norms after recessions.

Canada isn’t the only nation with this problem. The collapse of the Australian dollar and its over-reliance on natural resources has some very alarming parallels.However, let’s focus on Canada right now. There have been articles for years about this. Here is an example back in 2012 when things were on the upward swing.

Canada is in denial: There are painful drawbacks to being dependent on a single resource

One of the the things that has upset me is that when Muclair pointed it out, he was immediately attacked in the popular media and by prominent politicians from many sides.

The reality is that Muclair was correct. The collapse of the Canadian dollar since late 2014 to 2016, when it was near parity with the USD to today is particularly disturbing. Absolutely nobody can deny that the collapse of the Canadian dollar has been because the Canadian dollar is heavily tied to the price of oil. This has exacerbated the weak performance of the Canadian economy relative to the US economy (itself not in great shape, mind you), and the fall in oil prices has correspondingly led to a huge fall in the Canadian dollar.

There are very serious consequences to a sudden collapse in the weak Canadian dollar.  It has led to a very real decline in the purchasing power of Canadians. Manufactured goods now cost quite a bit more when imported. Other goods such as electronics cost quite a bit more now that the Canadian dollar is weak. Keep in mind that we are not just talking about consumer gadgets, but also essential goods. This winter, I have noticed the sudden (and dramatic rise) in the prices of fruits, vegetables, and other imported food products. That has very real consequences for the purchasing power of Canadians. Keep in mind that too the price of gasoline is in US Dollars, which means that a weak Canadian dollar does not necessarily mean correspondingly weak fuel prices.

Although I support a weak Canadian currency (to keep a strong manufacturing sector), I do not like how the Canadian dollar has dropped so rapidly. A weak currency is not always a bad thing, but if it does drop, it should drop for the right reasons and an over-reliance on a natural resource that has become cheap is not the right reason.

Manufacturing will not come back so easily

A weak Canadian dollar does not however assure a strong manufacturing sector. The reason is because manufacturing knowledge is accumulated over time. It took decades to build up Canada’s manufacturing sector, the knowledge, the skilled workforce, and along with it, massive capital investment. Although one of the ingredients, a weak currency is now present (at least unless oil prices return to their old hikes), does not resolve the other challenges. The only way that this could happen is if there is massive public investment in manufacturing.

The big reason why I am so heavily invested in the idea of Canada building a very strong manufacturing. It is a strong source of exports and unlike natural resources, is built on knowledge, rather than a non-renewable resource.  Manufacturing supports high paying job opportunities that would otherwise not be available for large numbers of people.

It is not a coincidence that the collapse in Canada’s manufacturing sector, much like that of the US, also was around the time that Canada’s middle class stagnated. According to Michael Rozworski, the bottom 80% of Canadian workers have seen their wages stagnate.  Actually, it is probably worse than that. The report was published in March of 2015 and oil prices have collapsed since then. Alberta, once Canada’s growth sector, has been pushed into a recession.   I suspect that an updated report published for 2016 would show wages in decline everywhere, including Western Canada, which had previously been a growth area.

There has to be a willingness on the behalf of the private sector though to take the risks in manufacturing, particularly given the costs and time frames involved.

Another option that is worth exploring is a large public sector of crown corporations that specialize in manufacturing. Perhaps if the private sector won’t (and I particularly emphasize the word “won’t” because large numbers of companies are sitting on cash that they will not invest), then there needs to be government intervention. It may be that the time frame is simply too long to rely on the private sector to do the necessary work.

It will take decades to build up a competitive industrial sector. There will be many losses and failures at first. One of the things that I will note is that the East Asian and the German governments see manufacturing as something essential to their national security. We Canadians would be well advised to do the same.

The path forward

One of the things I am not fond of is that manufacturing and natural resources are often portrayed as this great “zero sum” gain, one sector’s gain is another sector’s loss. Another alarming fact is that it has become a case of Western Canada (Alberta in particular) versus the traditional Canadian manufacturing heartland (particularly Ontario and Quebec). That does not necessarily have to be the case and it shouldn’t.  It is true that Ontario has seen decades of job loss, but this seems like a tactic more to pit people against each other than to solve any real problems.  The bigger loss I would argue is that the economy does not seem to be working well for residents of either part of Canada.

The most immediate thing to do would be to drastically increase royalties in the oil market. There should also be a massive public owned company, very similar to Norway’s Statoil. Back in 2010, Andrew Nikiforuk wrote a great book, Tar Sands, which noted that Canada’s royalties were only 39%, just half of Norway’s 76%. Most of the money that is collected, like Norway’s money, should go to a sovereign wealth fund. This should be used to sparingly to benefit future generations of Canadians. Right now this won’t see much benefit, but should oil prices return to their old highs or higher, it would mean that all of Canada could benefit.

The other is that Canada must develop an industrial policy. Protectionism should not be a dirty word, not when it (in long run, although there will be a painful transition in the short run), has the potential to improve the living standards of so many Canadians. There is a reason why Germany has done relatively well compared to the other European nations and that is due to the strength in its manufacturing sector.  Some of that oil sovereign wealth money could even be used to shore up manufacturing and invest in much needed training, along with capital expenses.  The bailout of the automotive manufacturers is an example, but instead of selling the shares, perhaps government should have held onto them and even expanded its stake to influence how the companies are run. This would involve appointing representatives to the Board on behalf of the People of Canada and using the shares to run the companies in such a manner that would benefit the public interest.

Elsewhere, I have written about how even Norway’s management of oil, which is often held as an example of what Canada should be doing, has been less than stellar.  I will note that Norway too has suffered immensely due to the decline in oil prices as of late. The difference between a manufacturing economy and a resource economy is that a manufacturing economy’s wealth is based on its knowledge, while a resource economy is based on its depleting natural resources. Canada should continue to extract, but put most of the money in research, education, infrastructure, and perhaps healthcare as well. These are areas that have seen far too little investment over the past few decades and have languished, particularly compared to the rest of the world.

I would argue that with this crisis, Neoliberalism has been so thoroughly discredited in the past few decades, first by the wage productivity gap, then by the 2008 Financial Crisis, and most recently, by this here in Canada.

Oil will continue to be developed of course, but if it is, it should be in a way that benefits all Canadians and does not lead to dangerous damages to the economy, such as the decline in manufacturing, along with the increased vulnerability to commodity prices.

I will be expanding this post in greater detail later on.

 

2 Comments

  1. Ernie dunbar

    And here, I thought that the collapse of Canada’s manufacturing sector (and probably the Dutch one too) has largely been thanks to China, and its ability to manufacture anything you want at a lower price. Then, the Chinese government subsidises shipping to other countries to eliminate that drawback for those that want to buy these manufactured goods.

    I’ve seen this happen again and again and again and again to many different sectors for any number of consumer goods. Bicycles used to be manufactured here in Canada by Norco (there used to be a factory in Burnaby, but no more), but because their competitors moved to cheaper Chinese manufacturers, they had to do the same, or they would be out of business today. The same is true of Giant and Trek, although those are American companies. The same has been true for precision optics, electronics, and kitchen utensils.

    The USA still has some big manufacturers, but often we’re talking about sectors like aircraft and military systems. Things that they will literally never outsource to China because of ideological concerns. Automobiles are still a big manufacturing sector, and that doesn’t appear to be going away in spite of strong competition from Japan and Germany. And then of course, there’s also America’s secret slave labour source – prison inmates. But they’re not trusted with building anything complicated or precise.

    And so, Canada goes back to its reliance on natural resources, something that we’ve always had plenty of. The logging industry is especially important in British Columbia, as is mining, and these sectors have been huge since before Canada was even a country.

    Reply
    1. Chris Liu (Post author)

      Thanks for commenting. My apologies on the delay as I found this in my spam filter somehow.

      Yes, the military manufacturing will remain in North America.

      The issue though is that not all natural resources are renewable. Forestry for example can be renewed. There are still issues. For example, why don’t we have a bigger manufacturing sector for the harvested wood? Even renewable resources can be depleted if not managed well. A good example might be the collapse of the fisheries in Newfoundland. Agriculture too with excessively intensive farming deplete the soils.

      Then there are the resources that cannot be renewed. One big one – oil cannot. That is going to have huge implications for Alberta, Texas, and a few other areas that are overexposed. Much of Northern Ontario is reliant on mineral resources, which are not renewable.

      The issues are:

      1. What happens if said resources are depleted?
      2. Even if not depleted, what if the price suddenly goes down? Take Alberta for example. It’s oil is heavy bitumen, which is much more expensive to refine than light sweet crude. When oil prices dropped, Alberta suffered, as did the rest of Canada.
      3. What if a focus on resources crowds out other sectors such as manufacturing and technology? A focus on natural resources leads to a strong currency which weakens demand for those sectors like manufacturing that you need when your commodities become less valuable or you run out? That’s the focus of Dutch Disease.

      Another big problem I see is that Canada’s population is rising. That means that there are fewer natural resources per capita, which means less wealth for the average living standards.

      There are nations with strong manufacturing sectors still. Germany in the EU is a very good example. I think that we Canadians could learn from northern Europe.

      Reply

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