Opinion: Time to stop fretting over the Canadian dollar

Shouldn’t the Bank of Canada be trying to prevent the
loonie from rising? Well, no.

Stephen Gordon 0

The Canadian dollar has recovered from the losses it suffered during the financial crisis, and seems set to reach parity with the U.S. dollar within the next year or two. There has also been a recovery in commentaries expressing concern for the effects of this appreciation on exports, particularly in the manufacturing sector. Between 2002 and 2008, our currency rose by 50%, and the manufacturing sector shed more than 300,000 employees. Shouldn’t the Bank of Canada be trying to prevent this from happening again?

Well, no. These arguments miss a key point of international trade theory: exports are costs. The reason we participate in world markets is to obtain goods that we can’t easily produce for ourselves; exports are the price we pay to foreigners in exchange for the imports we want. In a perfect world, we would obtain an infinitely large quantity of imports in return for an infinitely tiny amount of exports. So, a rising dollar is to be welcomed.

Although this idea is familiar to economists, some readers may find it surprising. So here’s a simple parable to explain why it’s true.

Suppose that we live in a country where everyone eats only doughnuts. We’re self-sufficient except for one thing: we need to import bananas to make banana cream doughnuts. Happily, foreign producers are willing to exchange truckloads of our trees for truckloads of their bananas. So some workers spend their time cutting down trees to send abroad, and the rest of us work on making doughnuts.

Now let’s suppose that foreigners are no longer satisfiedwith trees: they will now only exchange bananas for furniture. Some workers must therefore stop making doughnuts and start transforming trees into furniture for export. Even though the national accounts would record an increase in the value-added of exports, this development is bad news. The reallocation of workers away from doughnut production means that we make and consume fewer doughnuts.

What happens if foreigners go back to accepting trees for bananas? The workers who had been making furniture for export can go back to making doughnuts. Although the national accounts would show a reduction in export volumes, we are clearly better off: doughnut consumption will have increased.

This is obviously not a realistic representation of the Canadian economy, nor is it meant to be. But it corresponds closely to what happened in the last two expansions in many important ways. In the early 1990s, commodity prices fell, and the only way for us to obtain the imports we wanted was to shift workers to the manufacturing sector, and to increase the value-added of exports. But devoting more of our productive capacity to making things that are to be consumed by foreigners isn’t a path to prosperity, and workers’ real buying power stagnated.

In 2002, commodity prices rose, and we were able to get the imports we wanted with less resources allocated to the export sector. The expansion of 2002 — 2008 was characterized by a shift out of export-oriented manufacturing, and these workers were able to produce more for domestic consumption. Export volumes stagnated, but since we were getting better prices forwhat we sold to the rest of the world, real incomes increased.

Possibly the most important part of our parable is that it assumes laid-off furniture makers could simply go back to making doughnuts. What about those 300,000 manufacturing jobs lost in the real Canadian economy?

It turns out that almost all of that decline can be explained by attrition: workers who left the manufacturing sector were not replaced. Layoff rates — and in particular, permanent layoff rates — remained fairly constant, and they were generally lower than they were during the 1994 — 2002 expansion. A manufacturing worker was less likely to have lost her job during 2002 — 2008 than she would have been during the latter half of the 1990s.

If other sectors are expanding fast enough to maintain total employment levels, job losses in one sector are a manageable problem. Happily, job creation is one area where the Canadian economy has traditionally done very well. Unemployment among manufacturing workers actually decreased after 2002. Before the recent recession hit, employment as a proportion of the working-age population was at a record high.

In the short term, the Bank of Canada is right to be concerned with a dollar that may be appreciating too quickly: even though the recession is over, employment growth is still anemic. But in the medium and long terms, an increase in the value of our currency is a positive development. Canada’s prosperity is based not on the volume of our exports, but on their value on world markets.

Stephen Gordon is a professor of economics at the University of Laval in Quebec City.

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