The debate about whether or not Canada has "Dutch disease" can never get very far, because there is in fact no clear notion what it is. As far as I'm concerned, the term has by now been stripped of meaning: people are using the definition that is most convenient for their purposes.
So in this post, I'm going to summarise some of the points that have been raised:
1) The rise in resource prices. This has induced a shift of capital and labour away from manufacturing towards resources. This is not a subject of dispute. Some people seem to think that this is what "Dutch disease" is, but this phenomenon clearly does not deserve a pejorative label. HEC-Montréal's Simon van Norden put it very well in the comments in Mike's recent post on the topic:
When the world prices resources at a premium at to manufactured stuff, we export more of the relatively expensive stuff and import more of the relatively cheap stuff.
When it prices manufactured stuff at a premium to resources, we use the same strategy. I think Ricardo called this "comparative advantage."
I don't understand how an income-increasing change in the composition of output and employment can be called a disease.
2) The petrodollar. Again, I don't think that anyone disputes that there's a strong correlation between movements in oil prices and movements in Canadian dollar exchange rate. But this correlation is essentially the result of the Bank of Canada's inflation target; the shift out of manufacturing would have occurred anyway. If the Bank of Canada had kept the exchange rate fixed at – say – 0.85 USD, the prices that Canadian oil producers receive would be about 15% higher than what they get now. The oil sands would be that much more profitable, and would be attracting even more investment than they are now. Indeed, the reason Canada abandoned the Bretton Woods system of fixed exchange rates in the first place was that a flexible exchange rate dampened the swings generated by changes in resource prices.
There's not much point in pointing to the appreciating Canadian dollar as the cause of the reduction in manufacturing sector. If the government saw fit to order the Bank of Canada to force down and hold down the exchange rate, it would only succeed in creating inflation. (Not to mention the shitstorm associated with throwing away a policy that had provided twenty years of low and stable inflation )
3) Hollowing-out. As far as I can tell, the only point where the 'disease' tag really sticks is in the idea that manufacturing is a source of spillovers and other forms of increasing returns. The concern here is that if the manufacturing sector contracts "too much", it will lose its ability to recover if and when resource prices fall. I don't see much in the way of evidence for the notion that we should be using this as a basis of policy.
Firstly, we've seen this all before. As Simon also pointed out in that comment,
Over the past 50 or so years, we've seen a few of these "resource" price cycles. And we've seen the Canadian economy shift resources accordingly. (Remember how Alberta land prices fell in the '80s? and the western banks that went bust?) The ability to do so sounds like a very valuable real option to me.
Secondly, the sorts of manufacturing industries that have been losing employment are not the ones that are generally associated with R&D spillovers. The recent IRPP study that everyone's talking about puts it this way:
[B]ecause the manufacturing sector is traditionally a source of innovations that spill over to other sectors of the economy, the Dutch disease could, by weakening the major sources of innovation, lead to permanently lower growth rates for the overall economy. But the distribution of R&D spending combined with the industry-level analysis of the Dutch disease suggests that this is not a likely outcome in Canada. Almost 80 percent of manufacturing R&D is carried out in just four broad industry groups …, but the empirical analysis in this study … demonstrates than none of them has been severely affected by the Dutch disease.
Moreover,
An important caveat to the notion that the manufacturing sector is the motor of innovation across the economy is that the energy sector itself may provide technological spillovers to other sectors, and these may increase in the context of a resource boom. Even though the energy sector is perceived to be much less R&D intensive than manufacturing, the reality is that R&D spending in the oil extraction sector has tripled since 2003 and now exceeds that of the pharmaceutical sector by a comfortable margin. There is certainly anecdotal evidence that modern extraction techniques are far from “low tech.” Hydraulic horizontal fracturing technologies have vastly increased the amount of proved natural gas reserves in North America, and the oil sands industry has invested billions of dollars in technologies that have lowered the cost of extraction, increased the amount of economically recoverable sources and reduced the industry’s environmental footprint. However, very little research has documented the degree to which these developments have spilled over to other industries.
4) Wages. What amazes me most about the whole debate is that it's being conducted in terms of employment. But as we've been pointing out here on WCI for awhile now, most policy debates aren't about jobs. This is a case in point. In this debate, total employment is best viewed as fixed; what's at stake here are the sectoral composition of employment and wages. And the shift out of manufacturing has been accompanied by an increase in real wages.
5) Environmental implications. (This is a point that Mike has made often; I'm just repeating it here for completeness.) If an effective policy to price greenhouse gas emissions had been in place over the past 10 years, the pace of oil sands development would undoubtedly have been slower. But there's little reason to think that if carbon had been priced properly, more people would be working in the manufacturing sector. Steel producers would certainly have problems absorbing this new cost, and the fact that the auto sector sought and obtained special protection from the mild efforts of the Chrétien government suggests that the auto sector would also be concerned about its ability to absorb a carbon price. It's hard to see how a link can be made between pricing carbon and increasing (or at least, slowing the rate of decrease in) manufacturing employment without some sort of exemption for the manufacturing sector. And if the manufacturing sector is exempted, then it's hard to see how it could be defended against accusations that the carbon pricing policy is simply NEP 2.0. (That last line is also Mike's.)
I think the question "Does Canada have Dutch disease?" has been evacuated of meaning. The only meaningful thing we can do is discuss the effects of policy measures designed to 'cure' it. And we're still waiting for someone to put them on the table.
Worthwhile Canadian Initiative 
In this debate, total employment is best viewed as fixed; what’s at stake here are the sectoral composition of employment and wages. And the shift out of manufacturing has been accompanied by an increase in real wages.
No, this is a false point. The entire problem of Dutch disease is that total employment in manufacturing contracts more than employment expands in the energy sector. It does assume that total wages in the energy sector are lower than in the manufacturing sector. In means that on balance the country afflicted with Dutch Disease suffers a net loss of employment due to exploitation of an energy resource.
Dutch Disease proponents, like myself, claim that this is true. Paul Krugman, in his new book “End This Depression Now” has an unashamed focus on jobs. This argument is really all about jobs, total employment and therefore distribution and equity.
Determinant,
Strangely, I agree 100% with Stephen here.
If industry A (manufacturing) is more capital intensive than industry B (resource extraction), then a shift to industry B would result in an increased demand for labor.
The labor issue is totally separate from the quality of life issue — e.g. we want more capital intensive industries so that we all become richer in real terms with the same labor effort.
But if the goal is to maintain or increase labor demand, then you want the least capital intensive industries around.
Obviously all of the above assumes that markets clear, etc. We can debate that, but the lack of market clearing and/or adjustment costs is a (third) separate issue. I.e. you can argue that you do not want to be switching back and forth all the time because the markets wont be able to handle that without dropping a lot of people.
Here, a good argument can be made that volatility in commodity prices is one reason not to have your labor force primarily engaged in resource extraction, but I haven’t heard anyone make this argument yet, and it would be a tough argument to make as most of the labor force (in advanced nations) will be providing services.
I learned as an undergrad at Boston University that “Dutch disease” has a rather specific meaning.
It is a shift in the economy away from the tradable goods sector (i.e. manufacturing) in favor of the non-tradable goods sector (i.e. services), as a result of the differential inflation caused by having one dominant export, which would usually but not necessarily be a natural resource (it could also be foreign aid, or a big tourist attraction, or something like that).
The word “disease” was not supposed to refer to the economy as a whole, only to the the manufacturing sector, which would necessarily see a decline. Obviously the services sector and the natural resource extraction sector (or the tourism industry, or whatever) would not be diseased at all, and could (would?) in fact more than compensate for the decline in manufacturing.
But I agree that the term has evolved over time, and has been abused, which is unfortunate.
rsj, I think the oil and gas sector is one of the most capital intensive, as is mining for metals and minerals, much more than manufacturing.
I have to wonder why there isn’t mention of export services like tourism in relation to an increased value of the currency. If the $Cdn is up, so is cross-border shopping, so is Canadian travel abroad. Travel to Canadian tourism destinations like Banff and Whistler will be down.
Agree with both Jacob AG and Rod Smelser comments.
Corden and Neary (1982) has a model for ‘Dutch disease’: http://wy-sublettecounty.civicplus.com/archives/43/booming_secor_and_de-industrialization%5B1%5D.pdf
On page 831 it goes through effect ‘Dutch disease’ on factor incomes. Note that while real wages may rise labour may still be worse of e.g. demand for services increase, price for services increase, higher proportion of consumption on services = labour worse off. For example, I know in Australia there have been dramatic rise in cost of living in mining towns due to resource boom, e.g. housing rent going up by 10-20x, stores shutting down because can’t afford to pay the same wages as the mines etc etc.
Also specific factor in manufacturing can also be interpreted as immobile or unskilled labour. If you’ve got a mortgage/family can’t exactly move to the other side of the country, if you don’t have the right skills you can’t transfer to the mining sector, or if you’re a woman there aren’t to many mining jobs available etc. Those manufacturing specific/immobile workers are unambiguously worse off under the Corden and Neary model.
To repeat my comment in the other thread, it’s clear there is an aggregate gain from a resource boom, but those gains aren’t shared, in fact the losses can be and are disproportionately concentrated in some sectors such as manufacturing. Whether there should be a policy response is a normative question, I would guess if you’re on the wrong side of the boom your answer would be in the affirmative.
Having said all that there are policy responses that don’t necessitate ‘beggar thy neighbour’ policies. Here is an article going through some policy responses in the Australia context: http://www.melbourneinstitute.com/downloads/working_paper_series/wp2012n05.pdf
5) Environmental implications. (This is a point that Mike has made often; I’m just repeating it here for completeness.) If an effective policy to price greenhouse gas emissions had been in place over the past 10 years, the pace of oil sands development would undoubtedly have been slower.
And that’s why your response is incomplete. Environmental implications extend FAR beyond GHG emissions. Water, air pollution are externalities that the oil sands producers are not paying for.
You are not being complete, despite what Mike Moffatt says.
Wages: I don’t this can be entirely dismissed, since some people just don’t want to relocate or have strong barriers preventing it. Certainly asking large bodies of people to uproot themselves and settle down someplace else would significantly exacerbate the “hollowing out” problem you outline.
“The only meaningful thing we can do is discuss the effects policy measures designed to ‘cure’ it. And we’re still waiting for someone to put them on the table.” I agree that we should try to be much more specific than the politicians and media generally have been and I think this is a great post for trying to do so, but then there are lines like “And if the manufacturing sector is exempted, then it’s hard to see how it could be defended against accusations that the carbon pricing policy is simply NEP 2.0.” I think media and others have been quick to put words in Mulcair’s mouth when he didn’t really say anything substantial or even (as your post points out) well defined. This past week we’ve basically been hearing from every corner that the NDP have a socialist interventionist “hidden agenda.”
I think Mulcair brought that on himself, by making a link between environmental issues and Dutch disease. As Mike and others have mentioned, the only obvious way to go from “stronger environmental protection” to “increase manufacturing employment” is by way of a special exemption for the manufacturing sector.
The only meaningful thing we can do is discuss the effects policy measures designed to ‘cure’ it. And we’re still waiting for someone to put them on the table.
We can’t effectively move on to that until there is enough agreement that there is a problem. While I can accept the use of the term Dutch Disease is not being employed to your rigorous academic standards it is being employed in a manner that is sufficient for political purposes and general discussion amongst the public. So why not bend a little and accept that Canada is afflicted with Dutch Disease so we can move on to determining how severe the problem is and then on to determining the best course of action to eliminate or marginalize its effects.
Your arguments are useful but rather silly coming from a tenured prof who will never likely move universities. The jobs lost in Ontario very often (there is data on that) involved families with homes and TWO jobs and kids in school AND VERY SPECIFIC SKILL SETS. The portability of skill sets in the goods production sector is often seriously overestimated. You could shift from macro to micro to (heaven help us) politics because your skill set is portable within that range. I expect that even you would be challenged to hold a job in Alberta as a welder or pipefitter.
Maybe I could get a job as a consultant and troll comment boards.
Stephen,
During the German economic miracle (wirtschaftswunder), exports of manufactured goods increased dramatically.
In 1949, the German Deutschmark was 4.2 to 1 USD
By 2000, the German Deutschmark had appreciated to 1.75:1
In 1949, Japanese yen was 314.470:1 USD
By 2000, Japanese yen was 107.739:1
Source: Foreign Currency Units per 1 U.S. Dollar, 1948-2009: http://fx.sauder.ubc.ca
Neither Germany nor Japan has any oil or natural gas or uranium resources.
Did the manufacturing success (and annual productivity increases) of Germany and Japan contribute to the remarkable appreciation of the German Deutschmark and the Japanese yen?
How could Germany and Japan compete in manufacturing export market with the steady increase in their respective currencies over 50 years from 1949 to 2000 – if we accept the hypothesis that a steadily increasing exchange rate causes the decline of the manufacturing sector?
Is “Dutch disease”, perhaps unwittingly, suggesting that the strong performance of a particular sector of a particular country in export markets puts upward pressure on the currency of that country?
Restated, is the debate concerning the alleged decline and harm to Ontario manufacturing, in essence a discussion of declining competitiveness and productivity coupled with exports to slow growth economies of US and EU instead of fast growing economies of emerging markets – as suggested by Gov Carney in his April 2012 speech, Exporting in a post-crisis world? http://www.bankofcanada.ca/2012/04/speeches/exporting-in-a-post-crisis-world/
“Maybe I could get a job as a consultant and troll comment boards.”
The competition there is quite tough – neither showers not suits are required, and spell checkers usually take care of the grammar.
It’s hard to see how a link can be made between pricing carbon and increasing (or at least, slowing the rate of decrease in) manufacturing employment without some sort of exemption for the manufacturing sector.
Mulcair’s plan is to go after the source polluters and most manufacturing is not a source polluter.
ianlee,
just throwing in a few key factors, and key words.
1. DE and JP did never run inflation like the US did. I had a ton of discussion in the last few days (“the battle for the ECB”) about how to measure that exactly, and I think the US is off by 0.25 % even in measuring it.
2. There is this well known Balassa Samuelson Effect for PPP factor dependence on the (relative) GDP, see for example also the famous Goldman Sachs paper Nr. 99 (BRIC) for a formula
3. DE and JP did not “catch-up” in productivity like EM (emerging market) countries,
but to a large degree “re-built”, which enables faster growth at moderate savings levels, which were never so high, at least for Germany, as many people believe.
4. There are some more second order effects, some are described in the Goldman-Sachs GSDEER and related papers / models. So far you get with (not silly ISLM) but significantly extended Fleming Mundell models, lets say until 2000. Plenty of papers around. One can understand trade volumes, current account surplus http://www.slideshare.net/genauer/currencies with adding surprisingly little dynamics to it. You will have a hard time to understand slide 2, I did not have time, found a good way to make this more understandable. But feel free to ask. This might help me to help you and others.
5. Since about 10 years, or lets say since the “Asian crisis 1998” there is something new in addition going on, which I call “volume squeeze”. After the US squeezed cash strapped asians, they took this lesson to heart, and it is now getting to payback time.
Classic Supply and Demand relation are more and more distorted by generation / destruction volumes. As a key word the “global savings glut”. For this part to understand you have to dive into demographics, social security as it is now,
and 20 years down the road. I believe I understand this for DE, US, JP, China
new recent edition: http://www.oecd.org/dataoecd/37/41/49454618.pdf
For the OECD keep in mind, these guys know less than you hope, take it with a lot of salt !
For tax codes, no good public references, but important for the DE current account surplus since 2004
You might get some ideas from the comments in
http://ftalphaville.ft.com/blog/2012/05/18/1006351/a-bund-a-bund-my-kingdom-for-a-bund/?updatedcontent=1#comments
So far I think I understand most of it. Quantitatively.
6. Long term political strategies of China etc.
Here me too has to speculate, mostly.
Dutch disease is not about reallocation of capital. It what happens when a sector generates rent. If the price of oil was equal to its marginal cost, all resources would be used and the shift to oil would have no consequences except higher incomes for everyone. When you generate rent, the distribution process halts. The resource curse is that you have to build useless monument or buy military hardware. Their building is the only way to back the income into the popualtion.
Ok. in the very long run, we could all move to Alberta, Canada would produce so much oil from costly sources that the price would drop while the cost would rise, and roughnecks would pay $100 for a hot-dog so the waiter would earn the same wage and Stolper-Samuelson would be happy.
In the meantime, another 30-year old restaurant closed here two days ago as the staff decamped north and retired professors have been asked back as young ones can’t afford to migrate here and house themselves.
Money,money everywhere and no restaurant to drink a drop at.
IanLee & DavidN:
“Is “Dutch disease”, perhaps unwittingly, suggesting that the strong performance of a particular sector of a particular country in export markets puts upward pressure on the currency of that country?”
“Corden and Neary (1982) has a model for ‘Dutch disease’: http://wy-sublettecounty.civicplus.com/archives/43/booming_secor_and_de-industrialization%5B1%5D.pdf”
A booming sector model is a good way of analyzing an export oriented sector that combines export led growth with neoclassical labour market adjustment properties. In Canada, we tend to think of economic booms as resource driven (oil, wheat, etc…) but the reality is any export sector can be a booming sector and any booming sector if large enough can put upward pressure on a country’s currency. There has been criticism of oil in the West driving up the value of the dollar and hurting manufacturing but if we had a really successful manufacturing export sector, would there be the same criticism that it was driving an appreciation of the dollar? Likely not.
Just to stir your envy a little bit,
here in Dresden, DE, I have 100 restaurants in 20 min walking distance.
A Sunday open supermarket, and a “spätshop” where I can buy fresh bread and whatever to drink Sunday/Monday night 2 am at competitive prices.
10 min to high speed trains, 20 min to the airport, and I do leave the windows open over night without being disturbed by noise.
“Ich habe gar kein Auto”
I do not even have a car : -)
And we need good people (engineer and similar : -)
“Mulcair’s plan is to go after the source polluters and most manufacturing is not a source polluter”
That’s a pretty broad, and not wholly accurate, statement – as Mike points out in his latest thread. I wonder how popular Thomas Mulclair will be in his home province when he starts imposing a carbon tax on Alcoa or whether he’ll be able to hang onto those NDP seats in Northern Ontario once he starts taxing the Algoma steel mill (http://www.ec.gc.ca/ges-ghg/default.asp?lang=En&n=DF08C7BA-1#section3). And one would be hard pressed to argue that taxing source producers who produce inputs for manufacturing (coal and natural gas plants elecricity plants, transportation, chemicals, etc.) won’t affect manufacturers.
As an aside, it’s interesting to note that 6 of Canada’s universities have facilities on that list of large polluters.
I wonder how popular Thomas Mulclair will be in his home province when he starts imposing a carbon tax on Alcoa or whether he’ll be able to hang onto those NDP seats in Northern Ontario once he starts taxing the Algoma steel mill
Obviously the implementation will determine that. If done in a sensible manner the effects should be manageable and not cost the NDP politically in these regions.
And one would be hard pressed to argue that taxing source producers who produce inputs for manufacturing (coal and natural gas plants elecricity plants, transportation, chemicals, etc.) won’t affect manufacturers.
I wouldn’t argue that manufacturers won’t be indirectly affected this either. But having now watched McGuinty nearly phase out coal generated electricity it looks as though the effects will be relatively minor and quite manageable.
“I wonder how popular … ”
And there’s the problem. Excepting those who are not actually producing it, we are all ‘richer’ for paying too little for energy. For most of the economy, energy is a cost.
Aren’t the manufacturing job losses in Ontario maintly due to technological advances? I seem to remember Mike Moffat writing a post about this in connection with the plant closeures in London. If correct, it would seem to indicate that the “dutch disease” is not to blame.
“But having now watched McGuinty nearly phase out coal generated electricity it looks as though the effects will be relatively minor and quite manageable”
Where are you looking? Industrial electricity prices have risen steadily in Ontario over the last decade and has been one of the factors, couple with the rising dollar to be sure, that has crippled the Ontario manufacturing sector. The effect has not been minor. And it’s going to get worse. The only reason Ontario hasn’t seen serious electricity shortages (or had to rely on expensive non-base generating capacity) over the last few years is because Ontario’s economy was conveniently crippled by a recession. Based on current growth levels, and scheduled increases in generating capacity (i.e., not much), Ontario will have severe power shortages by 2018 when the oldest of OPGs nukes start going off-line.
The one mitigating factor has been the collapse in the price of natural gas as a result of increased natural gas production in the US, making it cheaper to fire up natural gas reactors.
“If done in a sensible manner the effects should be manageable and not cost the NDP politically in these regions.”
What makes you think that taxing local industries in Quebec or Ontario will be any more popular among Quebecers or Ontarians than taxing local industries in Alberta is with Albertans?
“I don’t understand how an income-increasing change in the composition of output and employment can be called a disease.”
If the income-increasing change were happening for enough people and if it were sustainable for a long enough period then I think most people would have to conclude it is a good thing. Problem is, I’m not sure that enough people are sharing in the income gains and I don’t think it is sustainable over the long run.
A good chunk of the lost manufacturing jobs over the past decade have been replaced by good jobs in the broader public sector. That is why your wage charts show growth. Clearly, that is not going to happen going forward, at least not in certain parts of th country like Ontario. If both the public sector and the manufacturing sector are not growing, where are the good jobs going to come from?
The manufacturing sector was able to spread the income gains much more broadly and that is why its demise is being mourned by many people. I can see why some people call it a disease.
Exactly, it’s a utilitarian argument. The idea is that Ontario’s manufacturing sector employed more people than Alberta’s energy sector does at present and the job losses in manufacturing due to currency appreciation have been greater than the gains in energy and energy services.
The paradox, or disease, is that natural resource exploitation has caused a total job decline when compared with manufacturing.
There really is no way the data will ever shake you from that belief, is there?
Has anybody looked at whether what’s happening to the Cda/US exchange rate over the past few years has been the Loonie rising or the Greenback falling?
Stephen,
I think you didn’t quite flesh out the third definition (which I believe is the true definition of Dutch Disease), or what you labeled the “hollowing out” hypothesis, that manufacturing has increased returns (ie technological achievements increases employment in manufacturing sector, while in primary commodity sector it reduces it). But why it’s a DISEASE is the effect it has on the exchange rate. The point is that if you’re looking for export led growth, your manufacturing industry is unable to compete due to the prohibitively high exchange rate…however, the two conditions that must be satisfied in this case is that, for one, a country’s model of growth is predicated on exports, while on the other the manufacturing industry is still in development ie its in infant industry mode. However, neither of the two are necessarily the case when it comes to Canada (which depends more on domestic consumption, and already has a fully developed manufacturing and service base). Hence Dutch disease has absolutely NOTHING to do with Canada, and anyone who says otherwise is abusing the term.
In other words, Dutch disease is only relevant when speaking of (generally speaking) developing nations, and not developed ones.
BSF, no I haven’t, but it’s still irrelevant due to the points I made. Dutch disease has no meaning on a country with already developed manufacturing sector.
Dutch disease has no meaning on a country with already developed manufacturing sector.
Right, because Holland was undeveloped…
the low lands were the very first “modern country” way before the UK.
And a typical example for default with uncontrolled finances.
What makes you think that taxing local industries in Quebec or Ontario will be any more popular among Quebecers or Ontarians than taxing local industries in Alberta is with Albertans?
Because you can sell it to Quebec and Ontario manufacturers with a side order of cooled off dollar. Mulcair can simply point out that while they will take a hit with the cap and trade the loss will be recouped with the lower dollar. Please note, I’m not saying Mulcair is right that a cap and trade will lower the dollar, only that this can be his political messaging.
I think a lot of the confusion has come about by equating Dutch disease with the resource curse which are two different things. Dutch disease has a specific definition within trade theory (see my comment above on Corden and Neary 1982) and refers to the effect attributable to trade between different currency regimes where a boom in one tradable sector can cause a sizeable appreciation in exchange rate resulting in recession/depression of all other tradable sectors, which can affect any currency regime, developed or developing. Dutch disease has it’s own wikipedia entry: http://en.wikipedia.org/wiki/Dutch_disease.
Livio,
Technically Dutch disease can come about through any booming tradable sector (not just resources) however it’s commonly associated with boom in resources (if I was to hazard a guess) because resources is unique in being about to generate the magnitude of capital inflow from consumption+investments in a short amount of time.
You’re probably right about the amount of the criticism, but I see that as a symptom rather than something artificial driven by political fear-mongering. Manufacturing is far more labour intensive than resources, in Australia manufacturing employs 9% vs 2% for mining when mining and manufacturing generate about same amount of GDP and I presume it would be the same in Canada. The boom in resources is not going to soak up unemployment from declining manufacturing even if there was no nominal rigidities in labour movement. It’s an issue that always comes up with trade but there are winners and losers (even if in the aggregate it’s a gain) so like it or not, this is a political economy dynamic to this issue as much as an economic one.
Having said all that, contrary to what Stephen suggested above, there are policy responses that don’t require direct central bank currency manipulation. As suggested in the second article I linked above, one policy response is to set up a sovereign weight fund investing overseas which will relieve the pressure on appreciation. Alternatively if you have a two-speed economy (unlike in the EU), you can leave the central bank to do it’s main job of controlling inflation and rely on fiscal transfers. Even the government generating a surplus will leave more room for the central bank to lower rates (assuming no lower bound issues) putting less appreciation pressure on the exchange rate. Policy intervention do not have to be protectionist or industry specific/targeted.
I think a lot of the confusion has come about by equating Dutch disease with the resource curse which are two different things. Dutch disease has a specific definition within trade theory (see my comment above on Corden and Neary 1982) and refers to the effect attributable to trade between different currency regimes where a boom in one tradable sector can cause a sizeable appreciation in exchange rate resulting in recession/depression of all other tradable sectors, which can affect any currency regime, developed or developing. Dutch disease has it’s own wikipedia entry: http://en.wikipedia.org/wiki/Dutch_disease.
Yes. That’s exactly what I have been discussing because Canadian manufacturing is highly reliant on export to the United States for its profits. It is therefore very sensitive to exchange rate appreciation. High loonie due to petrodollar effect => loss of profit margin due to decline in final US selling price wrt Canadian dollar costs => layoffs => Dutch Disease.
There really is no way the data will ever shake you from that belief, is there?
I was trying to express a view which disagreed with yours. What’s with the ad hominem?
You once said, Stephen, that in order to do econometrics you had to have an economic theory in mind first. It appears to me that you are a (neo)classicist. I happen to have different views.
I need to add an addendum,
‘The boom in resources is not going to soak up unemployment from declining manufacturing even if there was no nominal rigidities in labour movement’ however under the Corden and Neary model services should take up the rest of the slack (assuming no labour movement rigidity) due to the spending effect (in services).
This doesn’t change the overall qualitative result that labour-specific to manufacturing (i.e. labour that can’t transfer to services or mining) are unambiguously worse off.
regarding (4):
What’s a good policy response to unemployment in Ontario? Or is there no good policy response, and we just need to wait for people to move to Alberta?
Or is the answer too complicated for a quick comment response?
Even if you could point me in the direction of a reliable source on the subject (even a hard one!), I’d be appreciative.
Stephen Gordon,
Off topic, but this sounds up your alley.
http://newmonetarism.blogspot.ca/2012/05/sectoral-reallocation-and-labor-market.html#comment-form
Further, Stephen, your point (2) misses the economic mark. Again, pricing power. Ontario firm sells finished product to US customers in US Dollars, costs are 70% in Canadian dollars (less US imports). The CAD appreciates 30%, that 30% can’t be made up due to market competition in the US, thus the Ontario firm’s costs rise by 21% in a way that can’t be made up by increased revenue.
The result is falling margins leading to layoffs, wage reductions and the usual employment malaise.
This was explained to me by several managers at different firms, it was their world. Welcome to manufacturing in Ontario.
Why, despite an improving terms of trade over the past 10 years, is Canada suffering a $50 billion/yr current account deficit?
http://www.statcan.gc.ca/tables-tableaux/sum-som/l01/cst01/econ01a-eng.htm
Could it be that part of the rising value of the CDN dollar over the past 10 year is a speculative overshoot?
“Suffer” is the wrong word
Lots of sturm and drang. In further support of Stephen’s arguments, from Statistics Canada, John Baldwin and Ryan Macdonald, The Canadian Manufacturing Sector: Adapting to Challenges, 2009
“The decline in manufacturing’s share of the value of economic activity however, does not necessarily imply that manufacturing itself is in decline or, that it necessarily represents a deindustrialization of the Canadian economy. The decline in manufacturing’s share of activity may be the result of other areas of the economy expanding more rapidly, or the result of a society starting to value services like education, health care or financial services more than manufactured products. More importantly, the decline in manufacturing’s share of the value of goods produced does not imply that the absolute or relative size of the volume of goods has also fallen (which is at the core of the deindustrialization argument). Before we reach the conclusion that the economy is de-industrializing, we must examine the evidence that is commonly used to argue that there has been a decline in manufacturing industries”.
“We find little evidence of a moribund manufacturing sector in decline. We do find that manufacturing has undergone significant change in response to the numerous challenges that it faced”
And from Eric Lascelle, TD Economics study of the data, in May 18, 2012 Globe and Mail:
“Mercifully, Canada’s poor competitiveness just doesn’t seem to matter very much. Despite plummeting competitiveness since 2000, Canada has managed faster economic growth than the United States, more vigorous job creation (including fewer lost manufacturing jobs), and continues to gain on the United
States in the UN’s Human Development Index”.
“Could this charmed existence eventually prove unsustainable, as it did for Greece? The evidence is to the contrary. Canada’s foreign financial indebtedness has not materially increased since the episode began”.
“Instead of bemoaning poor competitiveness, Canadians should applaud the astonishing resilience of their economy. Yes, during periods of high commodity prices, resource-intensive countries like Canada shed competitiveness. But this is paired with no obvious diminishment to well-being, thanks to the material benefits of the resource wealth itself. Meanwhile, when commodity prices are low, resource firms struggle, but rejuvenated competitiveness puts manufacturing back on the offensive. This is an impressive and likely durable balancing act”.
And finally the empirical results from from the IRPP Study: Dutch Disease or Failure to Compete?
A Diagnosis of Canada’s Manufacturing Woes, (which corroborates Governor Carney’s conclusions in Exporting in a post crisis world):
“The results are more nuanced than conventional wisdom would suggest. Only 25 of the 80
industries (accounting for about one-quarter of total manufacturing output) show a significant
negative relationship between the US-Canada exchange rate and output. The effects are
most pronounced in small labour-intensive industries such as textiles and apparel. Larger
industry groups such as food products, metals and machinery are much less adversely affected
by the strong dollar, and these minor problems have generally been offset by strong growth in
demand. Interestingly, automotive industries do not show symptoms of the Dutch disease;
their weakness stems from cyclical changes in demand and lagging productivity growth”
ianlee,
‘How could Germany and Japan compete in manufacturing export market with the steady increase in their respective currencies over 50 years from 1949 to 2000 – if we accept the hypothesis that a steadily increasing exchange rate causes the decline of the manufacturing sector?’
To clarify some things, if the appreciation in exchange rate is due to increased demand for manufacturing then the manufacturing sector is the cause of Dutch disease and you should see the non-manufacturing tradable sectors decline.
In the case of a resource boom, the resource sector is the cause of Dutch disease and you should see a decline in non-resource tradable sectors such as manufacturing.
Dutch disease is not specific to manufacturing. The cause of exchange rate appreciation determines which sector is subject to Dutch disease.
DavidN – I was being ironic to make the point that you are now making.
I find the entire Dutch disease debate to be utterly surreal.
1. There is nothing intrinsic or magical concerning increasing resource revenues from exports – as money is fungible – and any substantial increases in inflows from a rise in any exports (mfg or resources or anything else exported) will place upward pressure on the exchange rate.
2nd shibboleth claimed by Mulcair, CCPA, CAW is that a rise in the exchange rate renders the mfg sector less competitive or uncompetitive. Yet, Germany and Japan for 50 years have demolished that argument, year after year, with increases in exports, at the same time as their respective currencies steadily appreciated – demonstrating that mfg exports are not completely tethered, in lock step, to the exchange rate.
I thought Simon de Nordren (?) said it best, “When the world prices resources at a premium at to manufactured stuff, we export more of the relatively expensive stuff and import more of the relatively cheap stuff.”
“When it prices manufactured stuff at a premium to resources, we use the same strategy. I think Ricardo called this “comparative advantage.”
That’s because Germany and Japan exchange rate appreciation is driven by demand for there manufacturing goods. You can’t have Dutch disease on your own sector …
I think this article by Dani Rodrik on International Trade and Redistribution is relevant to the discussion: http://www.project-syndicate.org/commentary/free-trade-blinders
‘I began the class by asking students whether they would approve of my carrying out a particular magic experiment. I picked two volunteers, Nicholas and John, and told them that I was capable of making $200 disappear from Nicholas’s bank account – poof! – while adding $300 to John’s. This feat of social engineering would leave the class as a whole better off by $100. Would they allow me to carry out this magic trick? Those who voted affirmatively were only a tiny minority. Many were uncertain. Even more opposed the change. Clearly the students were uncomfortable about condoning a significant redistribution of income, even if the economic pie grew as a result. How is it possible, I asked, that almost all of them had instinctively favored free trade, which entails a similar – in fact, most likely greater – redistribution from losers to winners? They appeared taken aback.’
Stephen;
Sorry….been travelling and missed the shitstorm you’ve triggered. I’m glad people found my earlier comment useful. Several people above have already done a good job laying out the basic trade theory, but let me add one historical remarks.
The Bank of Canada firmly nailed down its position on this issue throughout the 80s, 90s and 00s; a succession of governors and deputy governors were of the view that shifts in the relative price of resources played a big role in moving the CAD/USD exchange rate. This view was trotted out whenever some faction (from business groups wishing for tighter integration with the US to CEA presidents lamenting the Great Canadian Slump) would agitate for a monetary union with the US. The BoC’s counterargument was consistently that a floating exchange rate was reacting to real shocks and helping the Canadian economy adjust. I was therefore surprised to hear Dr. Carney the other day seemingly trying to deny that “Dutch Disease” affected Canada. I still need to read his exact words more carefully, many senior Bank of Canada officials have for years made public statements backing the Dutch Disease story; a governor who walks back from that line would leave those people twisting uncomfortably in the wind.
sorry, that should have read “carefully, BUT many senior….”
DavidN: “That’s because Germany and Japan exchange rate appreciation is driven by demand for there manufacturing goods. You can’t have Dutch disease on your own sector …”
Of course you can. No one has been granted an immunity from failure (which implictly assumes some omipotent agent possesses the authority to grant).
Restated, a firm or a sector can become less competitive over time, because competitor firms in that same sector in another country are achieving relatively higher levels of productivity increases due to e.g. more efficacious ICT or M&E or training investments or because you are granting larger wage increases in the firms in your sector relative to other countries.
Indeed, see the excellent ECB data that shows that Greek wages grew faster than all other EZ countries while German wages appreciated the least 2000-2010 in EZ. Per ECB, Greece is somewhere around 35% less competitive per worker hour while Spain is approx 30% and even France (IMF Sustainability Report, 2011) is about 20% below Germany per worker hour.