CURING THE DUTCH DISEASE IN CANADA Célestin Bimenyimana and Luc Vallée The rapid rise in commodity prices since 2002 has created a resource boom in western Canada and led to the rapid appreciation of the Canadian dollar. A strong dollar, however, threatens to erode Canada’s manufacturing sector, which greatly depends on exports. This phenomenon, referred to as the Dutch disease, poses a particular policy challenge in Canada due to the country’s geography and its jurisdictional asymmetries. Whereas the need for remedies prevails, traditional solutions fail. Solutions must account for the particularity of the disease in the Canadian context. La croissance rapide des prix des matières premières depuis 2002 a créé un boom pétrolier dans l’Ouest du pays et mené à une rapide appréciation du dollar canadien. Toutefois, un huard fort menace d’étouffer notre secteur manufacturier qui dépend largement des exportations. Ce phénomène, communément appelé « syndrome hollandais », représente tout un défi en termes de politiques publiques, en raison de la géographie du Canada et de l’asymétrie de ses juridictions. Les remèdes traditionnels n’ont pas produit les effets attendus. Or, pour être adéquates, les solutions devront tenir compte de la particularité du contexte canadien. he term Dutch disease refers to the phenomenon tual retrenchment in the resource sector or whether compe- whereby a country’s specialization in the exploitation tition from China and other emerging nations has definitely T and export of natural resources leads to the apprecia- rendered such businesses powerless to compete in world tion of its currency and the subsequent decline of its manufac- markets, even if they were able to benefit from a weaker dol- turing sector. More specifically, a resource boom, due either to lar. In other words, is Canadian manufacturing losing low- a major discovery or to a significant increase in the price of the value-added manufacturing jobs with limited potential to resource, results in high demand for the currency of the help Canada compete on world markets? Or is the Dutch dis- resource-rich country. As its value appreciates rapidly, local ease destroying the fabric of an otherwise thriving and manufacturers find it difficult to compete both domestically dynamic manufacturing sector crushed by a quickly appreci- and abroad. The main symptom of the Dutch disease is there- ating currency and unfavourable financial conditions? fore a contraction of the manufacturing output and employ- Arguments about the existence of a classic case of Dutch ment. The phenomenon was first observed in the case of the disease in Canada notwithstanding, it remains that persist- Netherlands in the 1960s (hence the name Dutch disease) fol- ently high commodity prices have precipitated a resource lowing an important discovery of oil and gas in the North Sea. boom in western Canada and a strong appreciation of the Canada is a resource-rich country, and has traditionally Canadian dollar. This phenomenon, without a doubt aided been a major producer and exporter of oil, natural gas and by increased competition from China and other emerging a number of minerals. The concurrent resource boom in countries, is causing Dutch disease-like symptoms in the western Canada followed by the rapid appreciation of the Canadian economy, where manufacturing is undergoing Canadian dollar since 2002 and the subsequent decline in major structural changes. Whether or not Canada’s experi- the relative size of the manufacturing sector, mainly located ence exactly resembles that of the Netherlands, facts on the in Ontario and Quebec, re-ignited the debate about whether ground strongly suggest that Canada might suffer from its Canada has contracted the Dutch disease. own strain of the Dutch disease. Relevant to the debate is the issue of whether recently Making the affliction particularly acute is Canada’s closed businesses in the Canadian manufacturing sector unique geography. As the resource boom and the manufac- would have been able to take up the slack caused by an even- turing bust are occurring in different parts of the country, the POLICY OPTIONS 75 NOVEMBER 2011 Célestin Bimenyimana and Luc Vallée concurrent reallocation of resources because of the country’s geography, currency. The rapid increase in world and jobs from manufacturing to servic- certain regions of Canada suffer the commodity prices from 2002 to 2007, es and resources, which would normal- adverse consequences of a resource and again since 2009, has indeed has- ly occur in a small country like the boom almost immediately, not only tened both a resource boom in Canada Netherlands, largely fails to take place. once the resource boom has faltered. and the appreciation of the Canadian Normally, the more serious impacts This is because the loss of jobs in man- dollar, as can be seen in figure 1. associated with the Dutch disease would ufacturing and lower economic growth While a strong currency is a chal- be expected to occur in the future, once occur in a concentrated fashion in cer- lenge to all exports, the rapid increase in the resource boom has run its course. In tain regions of the country that are natural resource prices gave a competi- the short run, there would merely be a unable to benefit from the boom tak- tive advantage to resource exports rela- tive to that of Canada’s Arguments about the existence of a classic case of Dutch manufactured goods. Consider, disease in Canada notwithstanding, it remains that for instance, Canada’s top two export products, crude petrole- persistently high commodity prices have precipitated a um oil and motor vehicles. The resource boom in western Canada and a strong appreciation price of crude oil rose from of the Canadian dollar. US$25.9 per barrel in 2001 to US$72.3 per barrel in 2007; substitution of jobs from manufacturing ing place in a distant region, due to a during the same period, the Canadian to the booming resources and services lack of labour mobility between dollar appreciated from US$0.63 to sector. It’s only in the longer run that regions separated by thousands of kilo- US$1.03. Although the appreciation of the loss of jobs and lower GDP growth, metres and regulatory and cultural bar- the Canadian dollar diluted the actual oil which would follow an eventual riers. The unfortunate nature of the price upsurge in $C terms, the price still unavoidable retrenchment of the disease in Canada thus poses particular increased from $C43 per barrel to $C70 resource boom, would be aggravated as challenges to both monetary and fiscal per barrel. On the other hand, according an atrophied manufacturing sector policies. to data from the International Trade would fail to fill the void left by the The initial problem with the Center, the unit value of Canada’s car weakening resource sector. Dutch disease is that massive exploita- exports also rose in US$ terms from tion and export of natural resources US$16,405 in 2001 to US$18,748 in n Canada, these long-term effects erodes the competitiveness of the man- 2007. In Canadian dollars, however, this I are a concern. For example, the ufacturing sector through the apprecia- translates into a substantial decline from heavily concentrated resources-based tion of the exchange rate. $26,039 to $18,201. economy of Alberta may dispropor- Foreign-exchange earnings of a It should therefore be no surprise tionately suffer from an eventual end resource-rich country increase rapidly that, over the 2001-2007 period, the of the resources boom — and it did, to as a result of rising resource export rev- value of Canada’s crude oil exports a certain extent, in 2008 and 2009. Yet, enues, leading to the appreciation of its increased from $16 billion to $41.8 bil- FIGURE 1. COMMODITY PRICES AND THE CANADIAN DOLLAR EXCHANGE RATE, 2000-09 WTI crude oil spot price IMF World commodity price indices Canadian Dollar Effective Exchange Rate Index (CERI) 100 300 130 All commodities index Metals index 250 Energy index 80 120 200 110 el 60 arr b r 150 100 40 1992=100 2005 = 100 US$ pe 100 90 20 50 80 0 0 70 1999 2001 2003 2005 2007 2009 1999 2001 2003 2005 2007 2009 Dec 00 Dec 02 Dec 04 Dec 06 Dec 08 Sources: Energy Information Administration; International Financial Statistics (IFS) IMF; Statistics Canada, CANSIM Table 176-0064. WTI = West Texas Instruments 76 OPTIONS POLITIQUES NOVEMBRE 2011 Curing the Dutch disease in Canada lion, whereas revenues from motor vehi- Canada (Quebec and Ontario). In Asian countries grew at annual rates cles’ exports declined from $41 billion to 2009, the manufacturing sector repre- above 6 percent for the past decade. $32.6 billion. And, accordingly, crude oil sented about 15 percent of total GDP As a result, fast-growing Asian replaced motor vehicles as Canada’s top and 84 percent of total exports in cen- infrastructure, industries and house- export product in 2006 (see figure 2). tral Canada, against 7.8 percent and 28 hold consumption help drain energy Rising oil prices ensured output percent respectively in Alberta. The and natural resources, as data from the and employment growth in the petro- mining and oil and gas extraction US Energy Information Agency suggest. leum industry. In contrast, given the industry, on the other hand, account- For instance, between 2005 and 2007, rapidly appreciating Canadian dollar, ed for 19 percent of GDP in Alberta China and India accounted for more most manufacturing firms have had to and 67 percent of total exports, but than 60 percent of the rise in world oil consumption. The initial problem with the Dutch disease is that massive exploitation and export of natural resources erodes the parked by increasing S demand from emerging competitiveness of the manufacturing sector through the economies, global demand appreciation of the exchange rate.