Sunday, June 17, 2012

The Phantom Menace: The OECD "Dutch Disease" Report That Never Actually Was

If you were to believe Canada's left, there's a malaise ravaging Canada's economy. And conveniently for them, they can blame it all on Alberta, where practically no one votes for them.

They call it Dutch Disease. And they're grasping at any straw they can find in order to make Canadians think that Canada has it. Including a report by the Organization for Economic Cooperation and Development which, they say, identifies symptoms of Dutch Disease in Canada.

But the report isn't the blanket confirmation of NDP leader Thomas Mulcair's wacky economic thesis that they think it is. In fact, there's far more in the report that disputes Mulcair, and reveals his economic ideas to be shortsighted and dangerous than there is anything that actually backs him up.

Mulcair claimed that Canada suffers from so-called Dutch Disease on account of what he considered an over-valued Canadian dollar, which he attributed to resource revenues, singling out the oilsands in particular. The Dutch Disease argument holds that resource exports, which help drive up the value of the dollar, "hollow out" a country's manufacturing sector. A country's exports become more expensive by comparison to their international competitors, driving down sales, and labour demand from the booming resource industries leave the manufacturing sector unable to compete for labour.

And so the symptoms of the so-called "Dutch Disease" are pretty clear: struggling manufacturing,  suffering sales, and lost jobs.

But to identify the symptom is hardly to diagnose the disease. And as a diagnostic tool, the OECD report actually tells a very different story. The report actually found what the IIRP did -- that the problem with manufacturing in Canada is below-nominal innovation. "While Canada has made great strides in macroeconomic and structural policy settings, and its academic research is world class, the pay-off in terms of business innovation and productivity growth has not been large. Business R&D is particularly low, despite significant policy support, suggesting substantial scope for improvement."

So the government of Canada has been doing its part. Particular sectors of the economy -- particularly the high-labour, low-wage subsectors of Canadian manufacturing that have been struggling -- have not been doing their part. Which, you may recall, was precisely what the IIRP concluded.

The report also found that opening sheltered sectors of the economy -- such as network communications -- up to greater competition would be beneficial. (Prime Minister Stephen Harper's government has been doing just this, and it's been driving the opposition batty.)

On the whole, the OECD report concluded that the problem with the Canadian economy is not the competitive pressures imposed by a higher exchange rate, but rather failures by specific sectors of the Canadian economy to respond to them. Which confronts Thomas Mulcair, the NDP, and his standard bearers with some very stark realities, and some equally stark challenges.

For example, Mulcair cites Canada's strong dollar as a problem, implying that something needs to be done about it. Yet the OECD gave Canada a sold thumbs-up on its monetary policy, although noting that the Bank of Canada should stand prepared to respond to inflationary pressures. So policy measures to erode the Canadian dollar don't seem to be in order.

So even if the OECD agreed with Mulcair that some symptoms of Dutch Disease are present, that's just one thing. And the presence of symptoms alone are not enough to diagnose the Dutch Disease. They also need to be able to identify the cause.

This is where some control comparisons come in handy. If the oilsands, and the energy industry in general, were really spurring Dutch Disease in Canada, then the struggles of Canada's manufacturing sector should be unique. But unfortunately for Mulcair and his fans, those struggles are not unique. Not even within OECD countries.

In fact, comparing declines across OECD countries is rather telling. While Statistics Canada identified a general downturn in Canadian manufacturing since 2004 -- something that Mulcair's followers point to as symptoms of Dutch Disease -- that downturn wasn't limited to Canada. The downturn in Canada's manufacturing industry was approximately 14%. But during the same period of time, Great Britain experienced a manufacturing downturn of 29%. Japan experienced a downturn of 24%. It was 20% in Belgium and Sweden. And an identical 14% in France.

This is all particularly telling, because it begs an important question: can the UK, Japan, Belgium, Sweden and France -- or most of the OECD. for that matter -- blame the decline of their manufacturing sectors on the oilsands? Do they even have an oilsands resource export equivalent that they can blame the decline on? Or is that general decline symptomatic of something else?

This is almost certainly why the OECD declined to cite Dutch Disease in their economic survey of Canada, and why a reporter for the Canadian Press had to do it for them: because the malaise of manufacturing is not uniquely Canadian, not attributable to Dutch Disease, and instead attributable to standard global economic forces.

Simply put, Canadian firms that placed their bet on high-labour, low-wage manufacturing in Canada made a poor bet. They're losing their sales to firms located in companies that have a competitive advantage in unskilled labour. In essence, they're paying the price for their own bad business decisions.

Thomas Mulcair and his followers point to this as evidence that Canada's economy is becoming "unbalanced," and that something needs to be done about it -- even though they're all lacking in ideas as to what exactly they want to do about it. They all seem to lack ideas about just what an "unbalanced economy" even means, and how to achieve a "balanced economy," and for good reason:

That isn't even remotely what the problem is. The OECD knows that, even if Mulcair and his followers so desperately want to pretend otherwise.

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