The Dollar and the Manufacturing Jobs Crisis

Jim Stanford and I appeared before the Industry Committee yesterday to speak to the impacts of the high dollar, particularly on manufacturing. Chaired by James Rajotte, the Committee has done some good work on manufacturing and  has worked in a relatively constructive and not totally partisan way to develop some useful reports and recommendations. Their report last year did urge targeted tax measures, something of a departure from neo liberal orthodoxy, and even questioned current trade policies.

The Committee now seems open to consideration of a refundable tax credit to support new investment in machinery and equipment. Jim and I both saw merit in this since it would be targeted to M and E, would support investment by companies now losing money, and could be used to access borrowing (a real issue for firms on the edge of going under.)

Both Jim and I spoke to the need for interest rate cuts to take some of the steam out of the Canadian dollar, and Jim was highly, and rightly, critical of recent comments by David Dodge suggesting that the dollar should be at a high 90 cent level – quite a departure from Bank of Canada practice of never commenting on an approporiate exchange rate.

I also note that Finance Minister Flaherty may be segueing from the line that all is for the best in this best of all possible worlds. He reportedly left yesterday’s meeting of finance ministers talking about some kind of assistance to hard hit sectors and communities.

I’ve pasted in below the notes I presented to the Committee:
“The manufacturing jobs crisis has cost Canadian communities almost 100,000 jobs to date this year on top of the more than 200,000 jobs already lost before 2007. The high dollar is now dramatically impacting on other sectors as well.

As a first step, we call on the federal and provincial finance ministers meeting tonight to strike a Task Force with high-level labour, government and business representation with a mandate to report to First Ministers early next year, and again before the next federal Budget.

The Task Force should consider how to reverse the alarming growth in our manufacturing trade deficit and the continuing, linked loss of good manufacturing jobs, including through changes to our trade policies; how to increase productivity and value-added in Canadian manufacturing, including the resource-based sectors, through government support for new investment in innovation, machinery and equipment and workers’ skills; and how governments might concretely assist Canadian manufacturers through Buy Canadian public procurement strategies linked to new infrastructure and environmental investments.

We also call on ministers to jointly remind the Bank of Canada that their mandate is “to regulate credit and currency in the best interests of the economic life of the nation, to control and protect the external value of the national monetary unit and to mitigate by its influence fluctuations in the general level of production, trade, prices and employment, so far as may be possible within the scope of monetary action.”  The recent very rapid and destructive appreciation of the Canadian dollar against the US dollar could and should  be moderated to some degree through interest rate cuts.

The manufacturing jobs crisis is shrugged-off by some commentators as of no great concern given our low unemployment rate and booming energy and minerals sector. But manufacturing is a key creator of jobs in other sectors of the economy, is important across Canada, and is vital to our long-term economic future.

A recent study by Informetrica Ltd for the labour movement calculates that a $10 Billion or  3.3% increase in manufacturing exports sustained over 4 years would generate 67,000 new direct manufacturing jobs, plus another 48,500 spin-off jobs, three quarters of which would be in the service sector (everything from financial and legal services, to hotels and restaurants). Most of the positive job impacts would be in central Canada (about one-half in Ontario and one-quarter in Quebec) but one in four of the new jobs would be in Atlantic Canada and the West.

The increase in exports would generate a significant increase in government revenues – enough to reduce the debt of all levels of government by $8 Billion, and enough to also finance new annual spending of $2 Billion on public services. This would create another 26,500 jobs.

As we are constantly told, Canada will do best in a changing global economy if we shift to production of goods and services which sell in world markets because they are innovative, of high quality and/or unique. With countries like China and India becoming major exporters, only a highly productive economy built on innovation, knowledge, modern machinery and equipment and skills will sustain high wages and living standards.

The last few years have shown that targeted investment measures are much more effective than across the board cuts to corporate tax rates, which do little to support manufacturing investments and disproportionately benefit the financial and energy and mining resource sectors where after-tax profits are already very high‘no strings attached. Further across the board corporate tax cuts could actually increase the exchange rate by encouraging more foreign takeovers of Canadian resource industries.

Far from being part of the “old economy”,  manufacturing accounts for the majority (56% in 2006) of all Canadian business investment in research and development. The manufacturing jobs crisis is hollowing out almost all manufacturing industries, not just those which are especially  vulnerable to very low wage competition. The auto sector, electrical equipment and computers – all considered to be well above average productivity sectors – have been among the big losers from the high dollar as production and jobs have shifted to Asia.

Canada’s deficit in the trade of manufactured goods has exploded in recent years, hitting $28 Billion in 2006. It is true that we are now exporting a lot of oil and gas and minerals, but resource exports can finance only about one-fifth of our imports.  An ever-increasing manufacturing trade deficit is unsustainable, and a regression to being a purely resource-driven economy is unsustainable and undesirable.

Changes in trade – slow or falling manufactured exports and greater import penetration of our market – are the key cause of recent declines in manufacturing production and job losses.

The unprecedented surge in the Canadian dollar from 85 cents US in early 2007 to as high as $1.10 in early November is deeply disturbing in terms of its implications for the health of the economy and the job market. Very rapid exchange rate appreciation is bad news for most enterprises exporting abroad, or competing with US and Asian exporters in the Canadian market.
The pace of job loss in manufacturing is clearly accelerating,  and manufacturers are widely expected to cut more jobs and close more operations in 2008.

An exchange rate which remains at or above parity will destroy cost competitiveness for other large and important portions of the Canadian economy such as tourism, cultural industries and those selling services into the US and Asian markets, not to mention those parts of the economy providing services to the manufacturing sector itself. Parity raises the fundamental question of whether the resource boom will destroy a significant part of our current economic base, greatly exaggerating regional economic differences.

Exchange rates can and do ‘over-shoot’ the level justified by fundamental factors, with permanent structural damage being inflicted if a serious over-valuation persists.

One estimate of a ‘correct’ exchange rate is that needed to equalize prices in two countries.  Another estimate is the exchange rate needed to equalize cost competitiveness in traded sectors. By both measures, our dollar is over-valued at above the low 80 cent US range. A continued seriously over-valued exchange rate will lead to more job losses and a major deterioration of our trade balance.

It is often argued that the surge of our dollar to at or near parity is justified by the resource boom.  However,  oil exports (crude oil plus refined petroleum products) make up only 12% of our total exports,  well below the 20% share of the struggling auto sector alone, and our trade balance with the rest of the world is slipping. The just-reported September 2007 merchandise trade surplus was the lowest in almost ten years.

The Canadian dollar is strong partly as a result of US dollar weakness. But our dollar has appreciated much more than the euro or the pound, and China, Japan  and other Asian exporters collectively account for a far larger share of the US trade deficit than does Canada, but have avoided the burden of adjustment by fixing or managing their own currencies.

There is clearly a close relationship between recent changes in Canada-US interest rates and the Canada-US dollar exchange rate. The Canadian dollar was trading at 85 cents US in early 2007, rising to 91 cents US in May. The widely anticipated increase in Canadian interest rates which took place on July 10 helped push the Canadian dollar to the mid 90 cent US range in July.  The surge of the Canadian dollar to parity with the US dollar and well beyond was then fueled by the half-point cut in the US federal funds rate on September 18,  followed by another quarter point cut at the end of October.  The Bank of Canada could have matched those US rate cuts, but chose not to.

On December 4, the Bank of Canada did reduce the target for the overnight rate by one quarter of one percentage point, but this has had only a small impact on the exchange rate since it merely matches the expected quarter point cut expected soon in the US. Moreover, the Bank of Canada has signaled that it is comfortable with a dollar close to parity, and appears unwilling to further reduce interest rates.

The Bank of Canada can and should state clearly that the current exchange rate is unsustainable, and cut interest rates to match the recent US rate cuts. This would still leave the Canadian dollar at an uncomfortably high level, but it would make a real difference. The Bank of Canada  also can and should (as it has, to a degree) work with other central banks to address global economic imbalances in a fairer way through upward revaluation of Asian currencies and a shift to more domestic-demand-driven growth in China and other developing Asian countries.

In conclusion,  the federal government should address the serious and worsening manufacturing jobs crisis by striking a national task force to develop policy proposals in the run-up to the next federal Budget, and by urging the Bank of Canada to cut interest rates.