Facing a shrinking manufacturing sector, Canada hasn’t been able to successfully shift focus and transition to a truly creative economy. This is reflected in the fact that, in recent years, Canada’s venture capital investment as a percentage of GDP has been at about 10%, which pales in comparison to 17% in the United States. It’s time for Canada to make a change—but to understand where we need to go, we must first understand where we’ve been.
From the late 1990s until recently, Canada enjoyed an unusually long boom in the prices of its commodities. The Bank of Canada’s commodity price index—which includes the 24 commodities produced in Canada and sold worldwide—increased by 181.5% from 1998 to 2011. By comparison, in the 14 years before 1998, the index dropped by 5.9%.
This commodity boom period—driven mainly by an economic boom in China—has been a gift to Canada and made us feel good about our economic condition as a country. It masked our inability to transform Canada into a more creative economy and left us vulnerable to external shocks. Our main response to such shocks appears to be offering our products and services at lower prices or making certain corporations and industries rely on government support. To better understand this response, we need to have a historical perspective on the performance of the Canadian economy.
In 1977, manufacturing in Canada and the United States was in the midst of a long-term decline (as it was in other developed countries), driven mainly by globalization shifting manufacturing to lower-cost countries. In that year, manufacturing constituted about 15% of the GDP in both countries. In general, developed countries had two potential responses to this global phenomenon: (a) to transform themselves and offer higher value-added products and services (the ‘new economy’) or (b) to stick with the ‘old economy’ through government support and a low exchange rate (i.e. lower wages). The more flexible nature of the American economy relative to Canada’s allowed it to find a new equilibrium that gave more weight to the first option. The impact of that has caused the Canadian and American economies to take different trajectories since the late 1970s.
Between 1948 and the late 1970s, the Canadian exchange rate was relatively stable, nearly at par with the US dollar. From 1977 to 2002, the Canadian dollar began a new path, declining from 94.04 cents US to 63.72 cents US. This led to a manufacturing renaissance in Canada. By 1999, the share of manufacturing in Canada increased to about 16%, while it declined to around 13% in the United States.
But relying on a low-wage strategy to sustain old-economy industries proved detrimental to Canada in the long run. Between 1961 and 1988, the ratio between Canadian and American business productivity was relatively stable at around 90%. Since 1988, the productivity ratio has deteriorated, reaching about 75% in recent times. So when the Canadian dollar changed course in 2003, driven by high commodity prices that propelled it close to parity in 2011, the Canadian manufacturing sector was decimated. By 2014, Canada’s share of manufacturing had dropped significantly, falling from a low-exchange-rate-supported, unsustainable level of 16% in 1999 to less than 11% five years later; in the United States, the decline during this same period was by a less dramatic one percentage point to 12%. This means the attempt to maintain our manufacturing base was unsuccessful and has prevented us from transforming the economy.
During that period of deteriorating productivity, no substantive steps were taken to increase productivity, mainly because the pain was eased by the commodity boom. We effectively ended up going through the painful transition but haven’t sufficiently replaced the old economy with a new economy. Maintaining, or increasing, productivity requires difficult structural changes that governments of all stripes are understandably hesitant to make due to political constraints related to the cost of transition.
There are voices in Canada that still echo the notion of resorting to a low Canadian dollar and offering government support as strategies to revive the economy. But as history teaches us, this isn’t a sustainable way to maintain and enhance our standard of living. And given Canada’s proximity to the United States, periods of a low Canadian dollar are a recipe for further deteriorating our productivity. Why? A low exchange rate acts to:
- increase the cost of importing productivity-enhancing equipment
- maintain low-value-added industries (that become artificially profitable) instead of replacing them with creative, high-value-added industries
- attract highly skilled individuals to the United States with higher compensation
What’s more, most of the manufacturing base we lost in the past decade and a half can’t be restored. This loss was part of a secular global trend that was artificially stemmed in the 1990s using a low Canadian dollar policy instead of taking a longer term view of modernizing the Canadian economy.
The current situation of low commodity prices is expected to continue for years. So we have an opportunity to take the steps that should have been taken years ago to transform Canada into a truly creative economy. In Part 2, I’ll discuss one approach to achieve such a transformation.