An Update on Canada’s Two Economies

What follows is a revised and extended version of the comments I made at a panel on the Canadian economy organized by the Bank of Canada and the IMF at the recent Canadian Economics Association meetings.

An Update on Canada’s Two Economies – Implications for Workers and for Monetary Policy
Andrew Jackson
Chief Economist
Canadian Labour Congress

The Hidden Jobs Crisis

Superficially, the Canadian economy and labour market are doing well. Economic growth is running above 3% at an annual rate, despite the US slowdown. We have a  low unemployment rate of just over 6% (6.1% in May) and a near all-time high employment rate of 63.4% ( This is the proportion of the working-age population with jobs.) The rate of new job creation continues to have been quite high in 2007 until recently,  matching the demand for jobs coming from the entry of echo baby boomers into the workforce, high rates of immigration, and a desire for later retirement on the part of some older workers.

The Bank of Canada and many economists believe that the job market is very tight and that our economy is operating “above capacity,” pushing inflation above the target rate of 2%. The Consumer Price Index was up 2.2%  year over year in April and the core rate, which strips out volatile items like food and energy, is running at 2.5%. The Bank of Canada said on May 29th that there is “excess demand” in the economy and that they will very likely raise interest rates in the near future. While the concept of operating “above capacity” takes into account more than the state of job market, continuing low unemployment and strong employment growth are driving fears of higher inflation.

Yet, as the Bank of Canada does recognize, wages are quite flat. And,  inflation is a decidedly regional issue. In April, only Alberta  had an inflation rate significantly above 2% (coming in at a very high 5.5%), and inflation is well below 2% in Ontario (1.8%) and Quebec (1.4%.) High inflation in Alberta is driven above all by soaring home prices, with the owned accommodation component up 17.7% in the past year.

From the perspective of  working people, the real issue is not inflation but why apparently low unemployment and an apparently tight job market are not benefitting them. It is not that long ago that the Bank of Canada, the International Monetary Fund and the OECD all thought that an unemployment rate much below 8% would spark a sharp increase in real wages. But this is simply not happening.

In fact, most workers are not sharing in the growth of national income generated by the resource boom, jobs are becoming more insecure and precarious, and many good jobs are being lost to industrial restructuring and the crisis in the manufacturing sector. More than 250,000 manufacturing jobs have been lost since 2002, and the pace of job loss has recently begun to accelerate. Unemployment may be low, but Canada faces a major crisis in terms of the quality of jobs. This crisis will be worsened if the Canadian dollar remains over-valued and interest rates are increased.  

Boom and Bust: Resources, Trade and the Manufacturing Crisis.

The Canadian economy is being driven by a geographically and sectorally concentrated resource boom. Prices of oil and gas and many base metals have soared, leading to increased production and major investments in new capacity, most notably the Alberta tar sands. The boom is being driven mainly by increased global commodity prices as a result of strong Asian growth. These higher commodity prices, along with the huge US balance of payments deficit, have led to a major appreciation of the Canadian against the US dollar.  Since 2002, the dollar has risen from a low of 62 cents US to a recent high of almost 95 cents. The high Canadian dollar is mainly a  function of shifts in Canada’s terms of trade, plus the weakness of the US dollar. Monetary policy has also played a role, as detailed below. Since major Asian currencies (notably those of China, Japan and Korea) are tied to the US dollar, Canadian competitiveness with Asia has been severely eroded.

Non resource based manufacturing and the forest industry are experiencing a major crisis due to
a slowdown in exports to the US. This reflects slower growth in the US market for products like paper, lumber, and autos and parts, and a loss of the Canadian share of the US market to rising Asian imports because of the high Canadian dollar.  Meanwhile, Asian producers have grabbed a much larger share of the Canadian domestic market for manufactured goods.  Since 2002, the US share of Canadian imports has fallen from 72% to 65% as the fall of the US against the Canadian dollar has mainly benefitted Asian exporters.

A large deficit in the trade of manufactured goods – defined as non resource-based goods – has opened up since 2002 and our trade deficit with China and developing Asia is now greater as a share of the economy  than that of the US.  Our overall merchandise trade surplus has shrunk despite high energy and mineral prices, and we now import about $1.25 worth of manufactured goods for every $1 of manufactured exports. (Manufactured goods are defined here as machinery and equipment, consumer goods and auto products combined as opposed to resource-based and industrial goods.)  We import $35 Billion worth of goods, mainly consumer goods and machinery and equipment – from China, but export just $7.7 Billion worth of goods – mainly resources – to that country in return. We also run large trade deficits with Korea, Japan and virtually every country in the world except the US, which is the almost exclusive buyer of our booming oil and gas exports. Laid on top of the problems caused by the high dollar are specific problems in the forest sector and the automotive sector, and the fact that many Asian markets for manufactured goods are not truly open to Canadian exports.

While some parts of manufacturing have remained profitable, the competitiveness squeeze caused by the high dollar and the huge and growing trade deficit with Asia has resulted in the loss of some 250,000 manufacturing jobs since the peak in 2002.  Another 31,000 manufacturing jobs were lost in April and May of 2007 combined as the second round of the manufacturing jobs crisis has intensified. Jobs have been lost to plant closures and to layoffs caused by lower production, a corporate drive for intensified productivity in remaining operations, and outsourcing of production inputs to other countries as part of the creation of global value chains. More job losses are clearly on the way now that the dollar has breached the 90 cent barrier, and indeed many layoffs which have yet to take place have already been announced.

There is evidence that relatively few manufacturers are taking advantage of the high dollar to purchase mainly imported machinery and equipment in an effort to restructure their operations in a more positive way for workers. In fact, machinery and equipment investment fell sharply (by 1.5%) in the first quarter of 2007, and business machinery and equipment investment is heavily concentrated in the primary resource sector.

Manufacturing Matters for Workers

The conventional wisdom is that re-structuring of the manufacturing sector is not a major problem, and that the economy is “adjusting well.”

However, manufacturing is an important direct source of almost 2 million good jobs due to above average productivity, in turn the result of higher than average capital investment per worker and a strong base of skilled workers. Manufacturing operations also support many spin-off jobs, including good jobs in business services and in transportation. It is true that there are also good jobs in the resource sector, but mines and oil and gas production are extremely capital intensive operations. Once built, they will require relatively few workers. Between 2005 and 2006, the mining sector (including oil and gas operations) created just 20,000 direct new jobs and total employment is less than one tenth the level of manufacturing.

Manufacturing is often denigrated as part of an “old economy” which must be replaced by a new “knowledge-based economy”, but more than two-thirds of all business research and development in Canada takes place in manufacturing, especially in industries like aerospace and electrical machinery and equipment. Skill levels in manufacturing have been rising.

There are big structural problems down the road if we allow manufacturing to shrink too much, especially if growth is driven by an energy sector which is based on non renewable resources being extracted far too fast, in an environmentally unsustainable fashion, with little value-added in Canada. As a key case in point, if the Keystone pipeline proposal is approved by the National Energy Board, increased production of bitumen from the Alberta tar sands will be refined in the US, just as dwindling natural gas supplies from Alberta have been diverted from value-added, job-creating petro-chemical production to natural gas exports. Most of the gains of the recent energy boom are being captured by owners of oil and gas companies, many of them foreign-owned.

Resource-led economies are prone to boom-bust cycles and to have a relatively narrow core of good jobs, as opposed to diversified economies with a strong manufacturing base which are more stable and have relatively more jobs in higher productivity sectors. Part of the recently much-lamented productivity slowdown in Canada is due to the fact that most of the workers displaced from manufacturing are moving to much lower productivity jobs in private services.

Looking at the impacts of the manufacturing crisis on workers, the simple fact of the matter is that manufacturing jobs are not easy to replace with jobs of comparable quality. They pay about $21 per hour on average compared to hourly wages of perhaps $15 per hour in private services where most of the net new jobs are being created. Manufacturing jobs are more likely than average to be full-time jobs and to provide pension and health benefits. The unionization rate in manufacturing is 30%, more than double that in private services. About one third of these manufacturing jobs are held by women and many are held by recent immigrants. Past experience has been that long-tenure workers displaced by industrial re-structuring experience significant wage losses in the range of 25% in new jobs.

There is some evidence that manufacturing jobs lost since 2002 have been above the manufacturing average in terms of pay and productivity. It is true that job losses have been heavy in sectors like clothing, textiles and furniture which pay relatively low wages, but there have also been major job losses in sectors like auto parts and fabricated metal products which typically pay more than the average. Tellingly, the majority (55%) of the  manufacturing jobs lost since 2002 have been unionized jobs, even though the unionization rate in manufacturing is just under one third. Straight hourly pay of unionized manufacturing workers is 3% higher than non union manufacturing workers (and the union premium is much greater if we compare union and non union production workers.) Most economists have found that unionized jobs are higher productivity jobs, justifying higher wages. In short, we are losing many of the best jobs in manufacturing, not just the low productivity jobs which are particularly vulnerable to low wage competition from developing Asian countries and Mexico.

There has been a partial offset to the loss of manufacturing jobs in the form of  increased demand for blue collar and especially skilled trades workers in the oil and gas industry and in mining. And many displaced workers have moved West to take these jobs and new jobs in other sectors, from construction to private services. The housing boom in central Canada has also, until recently, absorbed some laid-off industrial workers.

That said, there is evidence that the quality of new job creation is declining and adjustment problems are growing, just as the manufacturing jobs crisis is set to intensify with the recent run-up of the Canadian dollar from the mid 80 cents US range to 94 cents US.

The Poor Quality of New Jobs

In 2007 to date (December through May), the Canadian economy created 162,000 net new jobs (job gains minus job losses.) Of those new jobs, 112,000 or 69% came in the form of self – employment as opposed to paid jobs, and the number of employees in the private sector rose by just 1,600. In May alone, we lost 58,000 paid jobs in the private sector, offset by a big jump in self-employment (up by 56,000.)  Most self-employment positions are lower paid and less secure than the jobs of employees. The new jobs have also been disproportionately part-time.

We lost another 12,000 reasonably well-paid manufacturing jobs in May, on top of the 19,000 manufacturing jobs lost in April. The pace of job loss in this sector is clearly accelerating as a result of the recent run-up in the value of the Canadian dollar. Meanwhile, we have lost 16,000 primary resource jobs (in forestry, fishing, mining, oil and gas) since December.

It is clear that the quality of the new jobs falls far short of the quality of jobs being lost due to industrial re-structuring. Strikingly, almost all of the growth in paid employment (employees as opposed to self-employment) over the past year, May, 2006 to May, 2007,  (226,000 out of 229,000 positions) has been in sales and services jobs. This is the lowest paid occupational category, where many jobs are part-time. One third of  the new jobs created since December have been in the lowest paid industrial category of all, accommodation and food services. Within blue collar occupations there has been a shift from usually skilled and semi- skilled assembly and machine operator jobs, to labourers  Reflecting this shift to more insecure jobs in the lower paid parts of the private service sector, the CIBC employment quality index recently fell to its lowest level since 2002

Displaced industrial workers clearly face a huge hurdle in terms of finding new jobs of comparable quality. The situation is worst in Ontario. Here, 32,000 manufacturing jobs have been lost since December, but total employment in the province is up by just 21,000, and all of these new jobs were in accommodation and food services (up by 26,000.) The picture is only a bit brighter in Quebec, where 31,500 manufacturing jobs have been lost to date this year, but the rate of job creation overall has been a bit higher.

Flat Real Wages

The conventional wisdom is not just that our economy is “adjusting well”, but also that labour markets are very tight. However, if we look at wages, real wages for most workers are lagging productivity growth. Inflation is running a bit over 2% (2.2% in April) but in the fourth quarter of 2006 union wage settlements averaged just 2.1%, and a much lower 1.4% for private sector unionized workers. The reality is that few private sector unions can achieve more than a wage increase matching inflation with an unchanged benefits and job security package, and some employers are forcing real wage cuts on unionized workers  even in the face of supposedly high demand for workers and skills shortages.

Average hourly earnings of hourly paid workers are completely flat – increasing by 2.2% in February over a year earlier and thus exactly matching inflation. Average hourly earnings (of all workers) are rising at a faster pace – 3.0 % in May over a year earlier. However, higher rates of growth of top earnings are driving up the average. The most recent tax data for 2005 show that the income share of those making more than $250,000 – one in every 200 taxpayers – has hit 10%. People earning more than $100,000 collect roughly 20% of all income, but have accounted for about 30% of income growth over the past couple of years. Increased wage inequality is also suggested by the fact that the ratio of the median to average hourly wage has been falling, from 89.3% in 2002 to 87.8% in 2006.

Moreover, the national average for average hourly earnings is driven by increases of 4-5% in the four Western Provinces compared to just 1.7% in Ontario. (Interestingly, even in Alberta  real hourly wages are not rising if they are deflated by the high provincial inflation rate.)

Despite a supposedly tight job market, corporate profits continue to rise from an already near record-high share of total national income. After falling back a bit as a share of GDP in 2006, corporate pre tax profits rose by 3.1% in the first quarter of 2007, compared to a 2.0% rise in labour income.

Implications for Labour Market Policy

It is true that the boom in much of Western Canada has created some specific skills shortages, especially in the skilled trades and some health occupations. However, wage trends indicate no generalized labour shortages. Further, many workers are under-employed and are available to take good new jobs if and when these become available. Close to one in ten adult workers are still in low wage jobs (under $10 an hour), and many of them and others are in temporary jobs, own account self employment and involuntary part-time jobs. Many new immigrants and young adults are under- employed compared to their skills and qualifications. Now is the ideal time for governments to invest in the skills of the unemployed and under-employed, rather than resort to the quick-fix of importing temporary foreign workers who are highly vulnerable to exploitation and abuse since they are deprived of the right to change jobs.

Implications for the Bank of Canada

The rise in the exchange rate of the Canadian dollar since 2002 was, as noted, mainly driven by commodity prices and the weakness of the US dollar. However, neither of these factors explain the recent sharp rise of the Canadian against the US dollar. Since the end of March, the dollar has soared from the mid 80 cent US level to the mid 90 cent level. The major underlying cause has been a perception on the part of investors that Canadian interest rates will soon rise, and that US interest rates may soon fall. The Bank of Canada  confirmed on May 29th that some increase “may be needed in the near future to bring inflation down.”

The Bank of Canada maintains that it has only one goal, to keep inflation at the 2% target, and does not attempt to set a level for the exchange rate. However, the rise in the dollar will dampen inflation moving forward by reducing the cost of imports, and it is clearly hitting the real economy by deepening the manufacturing crisis in central Canada . A small rise in interest rates will do little or nothing to dampen house-price inflation in BC and Alberta.

Instead, the Bank of Canada should say that the Canadian dollar is trading at too high a level, and that interest rates will be cut if it does not fall.