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Dutch Disease

2015 January 19
by Ian Welsh

In light of the troubles the oil price collapse is causing Canada let us revisit the issue of Dutch Disease and explain how the Canadian economy worked for over a 100 years until Prime Minister Harper’s conservatives, by overly favoring resources and letting the Canadian manufacturing be terribly damaged, effectively ended the Canadian mixed economy.

It seems a lot of people don’t know what Dutch Disease is.  Here’s the short.

Dutch disease is when you sell a lot of resources and that makes your currency increase in value.  So if you discover a lot of oil, or oil becomes a lot more valuable because of a shortage so that you can produce tons of oil from the tar sands, you can experience Dutch Disease.

The consequence of your currency being worth more is that products you manufacture cost more for anyone outside your country.  So if Americans want to buy Canadian goods, it costs them more when the US and Canadian dollar are trading at about even than when the Canadian dollar cost only 80 cents American.

If something costs more, people will buy less of it, or they will stop buying from you entirely and buy from someone else who is cheaper.

What happened to the Dutch is that their manufacturing sector collapsed.  What NDP leader Thomas Mulcair, in Canada, is saying is that Canada is suffering from Dutch Disease.  That we are losing manufacturing jobs because of the higher dollar caused by all the oil from the oil sands we’re shipping out of the country, which raises the Canadian dollar.

I observed, many years ago, that the Canadian dollar had become a petro-currency.  It is now inarguable.

It is also virtually inarguable that Canada is losing manufacturing jobs due to the higher dollar.  It’s just arithmetic.  Unless you think price has no effect on sales, you can’t argue otherwise without excessive contortions.

Does this mean that Canada is suffering from Dutch Disease?  Depends where you put the margin.  One study, funded by the federal government, found that:

“We show that between 33 and 39 per cent of the manufacturing employment loss that was due to exchange rate developments between 2002 and 2007 is related to the Dutch Disease phenomenon,” says the study.

I am unaware of studies covering the period since then, and I don’t know if the study was correct.  Personally, I suspect it’s higher than that, but I haven’t run the numbers myself and I probably won’t (unless the Feds want to pay for my time.)

But, again, the argument is simple enough.  Unless you don’t believe in higher prices reducing sales, and reduced sales leading to job losses and company closures, you can’t really argue that the oil sands aren’t hurting manufacturing.  It’s just that simple.

The next question is “should we do anything about it?”

Canada has traditionally had what is known as a mixed economy.  When it comes to exports, we have manufacturing and we have the resource sector, of which oil is just one part.  Resources experience boom and bust cycles.  There is always another resource bust around the corner.  Always.  No resource has its prices stay high forever.  When resources are doing well, they support our exports.  When they’re doing badly, manufacturing takes up the slack.

As with any such oscillating economy, what should be done is that when one is booming, it subsidizes the other.  We don’t want manufacturing destroyed during high resource price periods, because there will always be low resource prices in the future.  So we tax the high resource prices and we subsidize manufacturing.  When resource prices collapse, the manufacturing sector subsidizes the resource sector.

If we allow the manufacturing sector to be badly damaged, it cannot easily be rebuilt when resource prices collapse.  Nations built entirely on resources are and will always be subject to economic collaps when the resource price collapses, and, again, it always does, the question is only when.

Mulcair has also talked about value add and that’s worth discussing.  Shipping raw oil, raw logs, unprocessed fish means you get the lowest prices possible and less jobs.  Value add means you refine the oil in Canada and sell it.  You turn the logs into paper or 2x4s in Canada.  You can or smoke the salmon, in Canada.  This provides jobs and the end goods sell for more.  It may be that processing will increase the price slightly compared to processing in the US or China, but that costs less sales than it would for the equivalent manufactured item.

Why?  Because resources are finite.  There is only so much oil in the world at any given price point.  There are only so many salmon, especially wild salmon.  There are only so many trees, especially trees that are good for construction grade timber.  Other countries will generally buy anyway, because there is nowhere else to get the product.  Sales may decline slightly, but profit often increases and so do the number of jobs in Canada.

When there is a bottleneck, as there is in oil production right now, especially, you can say “no, we’re going to process it here.”  If other nations don’t like it, tough.  They aren’t going to stop heating their houses and driving their cars to their suburban homes.  That is not happening.

So if you can extract a bit less oil, make more money overall, and have more jobs, why not do so?  That’s what Mulcair means by “value add”.

Finally, let’s move to cap and trade, which is what Mulcair wants to do with the tar sands.  Cap and Trade means you cap the amount of carbon emissions allowed by oil sands extraction, and you allow people to buy and sell the right to make those emissions.  You also tax those trades and emissions. You then use the money earned to subsidize manufacturing and research and whatever else will be the future of the country when oil prices collapse, which, again, they will, because resource booms always end, it is an existential certainty.

Once upon a time, the Canadian Maritimes were a resource boom area.  They sold fish, but more importantly they sold trees which could be made into masts, an incredibly valuable commodity.  Today, with pardon to my Maritime brethren, the Maritimes are in semi-permanent depression.

This is the future that Alberta faces.  They should want to be taxed, and they should want that money reinvested in other sectors, because those sectors are Alberta’s future long after the oil boom ends.  And the massive environmental destruction is leaving massive costs which will have to be cleaned up for generations to come, long after the boom days are gone.

Canada’s economy has worked, and we have not become Argentina (the country we would have been compared to before WWII) because of our mixed economy.  It is worth protecting, it is necessary to protect, if we want prosperity not now, but 10 years, 20 years or 50 years from now.  If we care about our children, or even ourselves 20 years from now, we must deal with the effects that massive exploitation of the oil sands is having on our economy and our environment.

Dutch disease is just arithmetic.  It is real, and it can devastate the future of a country.  Non-renewable resources are the epitome of found money, and what you do with found money is invest it in something productive, something which will support you once the found money runs out.

This is Canada, and this is our future we’re talking about.  If we actually care about the children we claim to love, we’ll acknowledge the simple arithmetic of what a high dollar does, and we’ll act to mitigate the damage.

(Update: Antonia Zerbisias had an article in February on Dutch Disease studies which is worth reading.)


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21 Responses leave one →
  1. Anonymouse permalink
    May 18, 2012

    Nice post but misguided. Ontario manufacturing is getting clobbered by trade with China, not western oil exports. Western oil exports don’t help Ontario under our current trade agreements, but there is no way Ontario can compete with Chinese products. What is needed is industrial policy – develop the oil sands but make sure there is lots of Canadian content. Period. Also make sure you have provisions for Ontario to use the profits to re-tool and re-invest in productive infrastructure. You would get lot of whining from the the multi-national oil companies, but then they can always go develop reserves in Iran or Iraq or some such place.

  2. Ian Welsh permalink*
    May 18, 2012

    We do not only compete with China and Chinese goods are not always more than 20% cheaper than ours.

  3. May 19, 2012

    Ian,

    Not sure if I entirely follow this sentence that you wrote:
    “It may be that processing will increase the price slightly compared to processing in the US or China, but that costs less sales than it would for the equivalent manufactured item.”

    So, you are saying that Canada would make more money (lose less sales) by processing their raw materials … even though the products may cost more due to higher processing costs than they would if they were processed in the U.S. or China … than they would if they just shipped out the raw materials to the U.S. or China and allowed them to process it into products?

    Z

  4. Ian Welsh permalink*
    May 19, 2012

    If we ship raw materials to another country, it may be cheaper to process them in that other country than it is in Canada. So the end price of the processed materials (say 2x4s or gasoline) might be higher if we process in Canada. But, if we process here we get the jobs here, the processed sells for more, and it’s not like there’s a surplus of oil in the world, so people will buy anyway even if price is higher.

    If they do buy slightly less of goods like timber, then so be it. Odds are that Canada is still better off because of final higher price + jobs being here, and being taxed here. And, of course, you can get really hardcore about it and really go into processing here.

    We should have bought Chrysler when we had the chance, and relocated it to Southern Ontario. Big mistake not too.

  5. The Tragically Flip permalink
    May 22, 2012

    I’m glad you put this up. It amazed me to see Western premiers piling on Mulcair like he said seawater is sweet or something. It’s self-evident that oil sales drive up the dollar which drives down manufacturing export competitiveness. If they want to argue that Canada is better off selling oil than cars, fine, I suppose that’s at least possibly true (though I highly doubt it for many of the reasons Ian describes) but it alarms me to see simple economic sense treated like strange gibberish.

    We really are becomming more like the US, where simply telling the truth about certain topics (Israel, single payer, both sides not equally to blame, etc) marks you some kind of weird extremist to be derided.

    Speaking of the Western Premiers, I can’t wait for Christie Clark to lose soon enough. I could comprehend Wall and Redford taking a ridiculous pro-oil position, but what does Clark get out of oil? A frigging pipeline (maybe)?

    Question for Ian: What can the sitting government (and maybe through the BofC whose independence is probably not as strong as one might read on paper) do to drive down the currency? It really seems like it was low during Chretien in the 90s, went up for Harper and that seems like the result of deliberate policy, not just happenstance of global currency markets.

  6. Ian Welsh permalink*
    May 22, 2012

    There isn’t too much, but you can tax the oil fields more, you can take the money and subsidize other industries. There will be complaints from various free trade deals, but, frankly, who cares? The US ignores such rulings whenever they want and so do the Chinese.

    The other option is simply massive intervention. Tax the oil fields and just spend all the money pegging the dollar. China has spent up to 10% of GDP keeping the Yuan where they want it.

    However, I don’t think we have the clout to do that, and I’d rather subsidize.

    Chretien/Martin wanted a low dollar and worked for it, but they also had the great oil collapse working for them for most of their period in power.

    Canada: Mulcair’s is the only leader with net positives, and the NDPs ratings are doing fine, so so far, telling the truth hasn’t hurt him. And let’s be frank, he ain’t winning Alberta anyway, much of BC agrees with him whatever the idiot premier says, and in Saskatchewan anyone who hates it wouldn’t vote NDP anyway (and a lot of farmers hate the oil boys.)

    To win Mulcair has to peel off enough of Ontario. And Ontarians have been screwed by dutch disease.

  7. Rob Grigjanis permalink
    May 22, 2012

    Mulcair’s is the only leader with net positives

    Ian, you haven’t given up on the NDP then? :)

    I like Mulcair, if only because he seems to enjoy pissing in the Boys’ Club’s corn flakes.

  8. Bernard permalink
    May 23, 2012

    once you sell all the “resources”, what is left to sell? sounds like they sold all the “goodies” in the Atlantic provinces and now they are left with memories of what they used to have, with no fall back/savings/return for selling all those goodies.

    sounds like stripmining, good for a short term life, but not for a long term focus. but that’s how business operates mostly nowadays.

    focus on the short term and ignore the long term. that “seize the day”  does wonder for the grand children and all those generations that have nothing left in to sell once those “assets” have been “sold” off.

    sounds like Canada is under the same Corporate Fascist control as America.

    i guess once all the goodies have been “exploited”/sold for the short term profit, the residents could always move to the next and current “stripmine.” sound very business friendly, the 1% will make out like the bandits they are.

  9. Ian Welsh permalink*
    May 23, 2012

    Rob,

    nope. I was worried when Layton died, but Mulcair seems to be playing this just right, and he’s also saying, consistently, that he’ll do some of the important right things. If he gets elected, he’ll have a mandate to do what he said he’d do.

    There are some other factors, as well, that make me somewhat optimistic.

    Of course, a ton of private money will be used to attack Mulcair and the NDP, so we’ll see. Gotta play it out, but Canada IS in play.

  10. David Kowalski permalink
    May 23, 2012

    Bernard,

    The resources of the Maritimes were far more “renewable” than the resources of Alberta. Trees can be planted and regrown. Of course, the rockier the soil or the biggerbth tree the harder the process becomes.

    The Grand Banks was simply the biggest fishing resource in the world but it was over fished and ruined. Restocking a lake or river is one thing. Restocking the Atlantic Ocean is something else.

    In the days of wooden ships and iron men, the timber could be turned into schooners locally. The ships could be used to fish. It was a nice, neat cycle. The earth will simply not produce more oil or more coal in the foreseeable future. You can inject steam or strip mine but at the end of the day, the resources will be gone eventually.

    What is the alternative to a resource-less economy with no manufacturing? Tourism? The summer season is short and the areas are more remote than direct competitors (Cape Cod or Maine for the Maritimes, Wyoming or Colorado for the Canadian Rockies). The high dollar strategy makes it even harder. Look at the tourism site for Newfoundland and Labrador (one province) and it is clear that they are competing against Alaska and/or Norway (whale watching and ice bergs).

  11. Chris permalink
    January 19, 2015

    What’s up with this in the first sentence, “the Canadian economy worked for over a 100 years until Prime Minister Harper’s conservatives vandalized it.” and then not a mention afterwards?

    Seems that cause should be included in your analysis?

  12. Don Giovanni permalink
    January 19, 2015

    This was basically par for the course in every 1st world subject state of the Empire, save for (somewhat) Germany. What the people or politicians in those countries actually thought was best at the time was entirely academic.

    (Though I don’t doubt that Harper thoroughly enjoyed playing out his preordained role in the proceedings. Iggy would have done the same horrible things as Harper, but would, being a soulless, heartless shell, have felt nothing one way or the other about it.)

  13. Ian Welsh permalink*
    January 19, 2015

    The cause is. Manufacturing collapses due to dutch disease, encouraged by Harper’s resource policies and neglect of manufacturing. This terribly damages the mixed economy. However, first paragraph expanded to make this more clear.

  14. Dan Lynch permalink
    January 20, 2015

    Thanks for talking about Dutch Disease — it seems to be ignored by 99% of economists.

    Not sure about your recommendation to subsidize manufacturing. Exactly how would that work? But you certainly could subsidize other things that indirectly would lower manufacturing costs — health care, education, pensions, infrastructure. Pay for those things with resource extraction taxes rather than with payroll and business taxes.

    Personally I say slap tariffs on imported value-added products. Of course that would violate free trade agreements, but it would not break my heart to end free trade.

  15. Ian Welsh permalink*
    January 20, 2015

    Well, it worked for over 100 years. I don’t see why it wouldn’t work now. Yes, tariffs would be useful, but Canada manufactures more for export than the domestic market. There’s plenty of ways of doing subsidies; direct and indirect.

  16. V. Arnold permalink
    January 20, 2015

    Manufacturing in the U.S. is forever changed. It will never again be labor intensive.
    The 3-D printing revolution is in its infancy and already houses, rocket motors (Space-X), prosthetics, cars, and the list goes on and grows by the week.
    And I haven’t mentioned robotics; self replication is already a reality.
    Humans had better reinvent themselves to a new purpose.
    The way we think about everything must evolve to the next paradigm.
    In the meantime, our greatest danger is the massive inequality that threatens our basic freedoms. Neo-serfdom is but a breath away…

  17. January 20, 2015

    ” let’s move to cap and trade, which is what Mulcair wants to do with the tar sands.”

    The only problem I have with cap and trade now is that it’s too little too late. It should have been implemented back in the 90′s. Now that we are close to a tipping point of CO2 in the atmosphere with 400ppm, doing things that simply drag out putting more CO2 in the atmosphere seems counter productive.

    Tar sands require more energy to extract the sulfur and other impurities it contains as opposed to the sweet crude sources that are quickly drying up, adding to the problem of increased green house gases being emitted.

  18. DMC permalink
    January 20, 2015

    That loud popping sound you heard last week was the oil bubble bursting, courtesy of the Saudis. They’ve all but explicitly said that they’re prepared to keep the price of oil as low as needed for as long as needed to knock the high price competition out of the market. And the tar sands cost about $80 a barrel to produce. Can they stay producing for 2 years of losing money on every barrel? The financial press is abuzz with the implications for various oil enterprises that were highly leveraged and the possible effect on oil based derivatives, which are starting to look like the mortgage backed junk bonds of the last financial crisis. This has implications for everybody that’s gotten late into the oil game, when the prices were high enough to justify the expense, from North Dakota to the North Sea.

  19. Peter permalink
    January 22, 2015

    From Stats Canada:

    Shrinking employment in manufacturing is a common trend in almost all OECD countries. From 1998 to 2008, the United States lost close to one-quarter (4.1 million) of its manufacturing jobs. Elsewhere in the OECD, from 1990 to 2003, manufacturing employment fell by 29% in the United Kingdom, 24% in Japan, 20% in Belgium and Sweden and 14% in France. Canada’s manufacturing industry lost 278,000 jobs (1 in 6) from 2000 to 2007, which reduced the sector’s share of total employment from 16% to 12%.

    None of these countries have currencies that could be termed petrodollars and I doubt anybody would argue Harper was behind their manufacturing woes. Yet Canada seems to have done better than most of them, probably because the resource and manufacturing sectors are more interdependent than these analyses commonly suggest. Exactly what manufacturing jobs do you say wouldn’t have been lost if Harper hadn’t implemented his “resource policies”?

  20. Ian Welsh permalink*
    January 22, 2015

    So, you (or Stats Can) compared different time periods and a hodgepodge of nations (each of which has its own specific causes) and then you want me to specify “exactly” what jobs were lost, which is to say, do something impossible, at great cost of my time (only God could specify “exactly” what jobs were lost.)

    Either prices affect sales in items with price elasticity (most manufactured goods), or they don’t. Feel free to make the case that they don’t. If you can’t, then you have no case that the increasing Canadian dollar had no affect on sales.

    If you require a “study” to prove it, one is linked in the post above. According to that study, which was funded by the Federal government (ie. the funder has reasons to prefer a different result), one=third of manufacturing job losses were due to Dutch Disease. That’s a lot of jobs, in a study whose bias would be expected to be towards the low end.

    AKA. Don’t waste my time.

  21. Peter permalink
    January 22, 2015

    Oh, this won’t take much of your time.

    I’m not a fool and I know currency appreciation is a negative for manufacturing exports. But there are many other factors in play and it is a distortion to present resource development and manufacturing as win-lose polar opposites. Switzerland is an export success despite decades or currency appreciation that had nothing to do with natural resources. Norway is hardly Saudi Arabia. The decline of manufacturing jobs in Canada took place for the most part when our currency was weak. Plus the Canadian federal government has limited control over the value of the currency and the pace of resource extraction, which is largely controlled by the provinces.

    Only 11% of Ontario jobs are in manufacturing and a good percentage of those involve manufacturing from resources. The service sector writ large employs 79%. Wouldn’t it be important to know how many of the latter are derivative in some way from resource extraction vs. manufacturing?

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