"Does Canada have Dutch disease?" is a question without a meaningful answer

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.

 

Comments

[Determinant]

What's the plan here?

Phase 1: open up a discussion on the subject.
Phase 2: craft a basic plan based on what was learned from that discussion.
Phase 3: sell said plan to the public in order to win enough support to form government.
Phase 4: expand on the basic plan using government resources to fill in missing details as well as an implementation schedule.

This is how the process works and must work because no opposition party has the resources to craft a detailed plan academics like you won't nitpick apart.

Yep. That's what I suspected all along and that's why I voted for Mulcair in the NDP leadership convention. Smart guy, I want to see him be PM.

[The Keystone Garter]

Re: aluminum, I'm for killing the industry with a carbon tax if that's what it does. Retrain workers, maybe help the new magnesium/carbon-fibre/CNT company R+D or market or somehow initial sales subsidy, of new industries.
http://www.differencebetween.net/object/difference-between-aluminum-and-magnesium/
Magnesium needs better coating; this can be done by aluminium industry in Que.

http://en.wikipedia.org/wiki/Future_car_technologies
CNTs and carbon fibre use hydrocarbon precursosrs AFAIK and if China without tax is CNT supplier, need tarriff (not popular)....Magna could do most of these. Fewer sales now with tax, more later (when boomers age).

Roads are used by trucks to bring many goods, not just cars, in response to carbon taxing cars instead of gasoline. You can tax the downstream users instead (keep in mind sell exactly same revenues of oil as paying upstream), you just have to pay for more beauracracy. I like upstream at least for oil and tar, because they can afford it. N.A. Car makers got free plants and still couldn't turn a profit with their big lumbering models. US Minerals Survey is good reference for what can and can't be substituted.

[Robert McClelland]

Ed Broadbent was talking about this issue in 1982!

And yet there's very little research into the effects of Dutch Disease in Canada. So little in fact, that a great many people are denying it even exists.

[Mike Moffatt]

Once again, two issues are being conflated - "Dutch disease" and "polluter pays". Why did the NDP feel the need to link these two ideas when they can't even keep them straight?

[Mike Moffatt]

"And yet there's very little research into the effects of Dutch Disease in Canada."

And this simply isn't true either. Look at Google Scholar. Lots of research, going back decades.

[Simon van Norden]

"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"

At the risk of getting sidetracked, are you really sold on this assertion, Stephen?

I've thought of oil price shocks (and other changes in world prices for natural resources) as shocks to Canada's terms of trade. I'm guessing that we'd both expect those to affect Canada's (real) exchange rate regardless of what the BoC is doing. (BoC official might also give us a lecture on the need to distinguish between shocks to the price level vs inflation shocks, or the difference between targeting "core" vs broader measures of inflation.)

[Stephen Gordon]

I was thinking "as opposed to targeting the nominal exchange rate".