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Dutch Disease

2012 May 18
by Ian Welsh

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.)

10 Responses
  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).

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