Finally, Canada Goes to School on Dutch Disease

A growing political spat between Alberta Premier Alison Redford and Ontario Premier Dalton McGuinty has highlighted the deleterious impact of fast-growing oil exports on the rest of the Canadian economy.

When Redford, whose party has supported rapid oil sands expansion, recently asked McGuinty to support the petroleum mega-project as a national economic driver, McGuinty refused to do so.

The premier of Canada's manufacturing base then explained that the project had turned the loonie into a petro dollar and thereby undermined the competitiveness of Ontario's economy.

"That has knocked the wind out of Ontario exporters and manufacturing in particular," explained McGuinty.

"The only reason the dollar is high -- it's a petro dollar, right? It's been driven by the global demand for oil and gas to be sourced in Western Canada.

"So if I had my preferences, as to whether we have a rapidly growing oil-and-gas sector in the West or a lower dollar benefiting Ontario, I'll tell you where I'd stand -- with the lower dollar."

The controversial oil project accounts for more than five per cent of Canada's GDP and more than 30 per cent of its exports, as well as multi-billion dollar revenues for Ottawa.

Redford, whose party has ruled Alberta for 40 consecutive years on the basis of its oil wealth, called McGuinty's analysis faulty. But a growing number of economists and reports say the facts solidly support McGuinty.

They argue that the Dutch Disease, a well-known affliction of oil exporting nations, has already damaged Canada's economy by raising the value of the Canadian dollar and eroding central Canada's manufacturing base.

Symptoms appear in manufacturing

Avrim Lazar, head of the Forest Products Association of Canada, was one of the first to sound the alarm.

"The obvious signs of Dutch Disease have been in place in Canada for some time, yet there was a collective complacency in the Canadian economic establishment," said Lazar in a 2008 speech. "This complacency has allowed policymakers to remain adamant that everything is fine. Only now are policymakers beginning to wake-up to the realization that the Canadian economy is not as immune to Dutch Disease as some had predicted."

Statistics Canada reports, for instance, that between 2004 and 2008 one in seven manufacturing jobs disappeared in Canada (322,000). The majority of these losses took place in Quebec and Ontario.

Just last November, two Montreal economists writing for the Institute for Research On Public Policy concluded that Canada's manufacturing base was suffering Dutch Disease-like symptoms and that commodity exports driven by oil had been hollowing out the nation’s economy since 2002.

"The initial problem with the Dutch Disease is that massive exploitation and export of natural resources erodes the competitiveness of the manufacturing sector through the appreciation of the exchange rate."

Added the 2011 IRPP report: "The effects of higher raw materials prices and of a stronger Canadian dollar on various sectors of the economy are a particular concern for regional wealth distribution. In Canada, 95 per cent of oil reserves are located in Alberta, whereas 75 per cent of manufacturing output is produced in central Canada (Quebec and Ontario)."

The economists called for a national policy that stabilizes the currency and that would also encourage both Alberta and federal governments to save more of their oil wealth in a sovereign fund. But a Canadian program to deal with the Dutch Disease caused by oil exports would not be easy because it "would likely require the participation of the different levels of governments," they said. 

An 'entrenched' syndrome

An independent investment firm MacroResearchBoard reached even more damning conclusions last April 2011:  

"A severe case of Dutch Disease has dramatically reduced the breadth of the Canadian business sector over the past decade, hollowing out manufactured goods exporters and making the nation increasingly reliant on commodity demand. Canada has often been referred to in jest as the 51st state, due to its historical reliance on the U.S. as a key export market. However, it is becoming more accurate to regard Canada as another Province of China," wrote MRB partner Phillip Colmar.

Economist Robyn Allan also cited the Dutch Disease in her critical report on the economic impact of the Northern Gateway Pipeline: 

"To the extent that the Dutch Disease does exist in Canada, Northern Gateway represents an entrenchment of the syndrome. The project promises a sustained increase in the price of crude oil which will serve to appreciate the Canadian dollar, raise inflation and interest rates. Those pressures will work negatively on Canada's other exporting sectors to decrease output and employment further."

A 2012 study by European and Canadian economists found that 42 per cent of the appreciation in the Canadian dollar was due to the resource boom and that the Dutch Disease accounted for between "196000 and 220000 jobs lost in the manufacturing sector for Canada."

The phenomenon takes its name from the rapid development of natural gas reserves off the coast of the Netherlands in the 1970s. Gas exports changed the value of the guilder and totally rattled that nation’s economy.  

Ever since then, oil-exporting regions including Alaska, Venezuela, Iran and Louisiana have experienced the disease, which often makes petro states highly vulnerable economic monocultures.

"Persistent Dutch Disease provokes a rapid, even distorted, growth of services, transportation and other non-tradeables while simultaneously discouraging industrialization and agriculture -- a dynamic that policymakers seem incapable of counteracting," wrote Stanford political scientist Terry Lynn Karl in 1997.

Her classic book on oil booms and petro states, The Paradox of Plenty, has now become required reading for Canadian politicians.