Appreciate the Appreciation: Imported Inputs and Concern Over Dutch Disease

Abstract

If anything is to blame for a higher dollar having negative effects on the Central Canadian manufacturing sector, you are not likely to find it in any “Dutch Disease” supposedly caused by Alberta’s oil sands. Contrary to popular belief, the higher value of the Canadian dollar may even help Central Canadian manufacturers grow stronger, cut costs, and create jobs. The idea that a booming, commodity-driven dollar is hurting Canadian goods exports, afflicting the country with so-called Dutch Disease, may be popular among certain politicians, including federal Opposition leader Thomas Mulcair and former Premier of Ontario Dalton McGuinty, but is not supported by the facts. It turns out that the simple economic theory these politicians have in mind is incomplete. A more thorough, data-driven look at the nation’s manufacturing sector reveals that Canadian businesses rely very heavily on imported materials and equipment as inputs in the manufacturing process. Canadian industry overall has one of the highest import ratios for such intermediate goods in the OECD, roughly twice as high as that of the U.S., the European Union and Japan. Compared to all other sectors, manufacturers are the heaviest users of imported materials and equipment, with more than 40 per cent of their inputs coming from other countries. A higher dollar may make it more expensive for foreign buyers to purchase Canadian manufactured goods, but that effect appears to be more than offset by the savings that Canadian producers enjoy with a higher dollar that makes possible cheaper imported-inputs and lower cost of production, which have a lowering effect on prices. The net result is that Canadian manufacturers actually get more benefit from a higher dollar, and the regions that get the biggest boost from it are the Central Canadian provinces of Ontario and Quebec. Policy-makers looking to aid the Canadian economy as a whole, and the manufacturing sector in particular, should stop worrying about Dutch Disease and, rather, welcome a higher Canadian dollar. But more than that, they should design policies that are better tailored for an economy that relies so heavily on imported intermediate inputs. Policy efforts would be far better put to eliminating tariffs and other trade barriers that make imported inputs more expensive, and thus hamper Canadian competitiveness. Policies should also focus on improving productivity, by inviting foreign investment, rather than subtly discouraging it through vehicles such as the Investment Canada Act. And certainly, anything that forces businesses to “buy local,” as Ontario’s Green Energy Act requires, will only stand in the way of Canadian businesses taking advantage of our higher dollar by importing lower-cost inputs from abroad. If policy-makers want to help Canadian factories, they shouldn’t complain about Alberta but instead focus on improving their domestic economic policies instead.