OTTAWA - The belief that the commodities boom of the past decade caused the decline in Canada's manufacturing sector is being challenged in a new report that also takes a swipe at the notion of the loonie as a petro-dollar.

The report, issued by the Macdonald-Laurier Institute and written by economist Philip Cross, argues that manufacturers' troubles stem more from structural economic changes than a higher Canadian dollar.

And it suggests that, in some ways, the commodities boom and its effect on the dollar actually helped the factory sector adapt.

(STORY CONTINUES BELOW SLIDESHOW)

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  • It Began In The Netherlands

    In 1977, <em>The Economist</em> coined the term "Dutch Disease" to describe the phenomenon of economies whose industrial bases suffer when large deposits of energy, such as oil or natural gas, are found. The magazine named it "Dutch Disease" because of the rapid deindustrialization seen in the Netherlands in the years after a major offshore natural gas find in 1959.

  • Skyrocketing Currency

    One of the effects of becoming an energy-exporting country is that speculators will start treating that country's currency as a "petro-dollar." The value of the currency rises (and sometimes falls) with the cost of the country's energy exports, which often means it becomes too high in value for exporters in other sectors. Those exporters then see their sales decline, and manufacturing suffers as a result.

  • Direct Deindustrialization

    As the energy export sector grows, it attracts workers from other sectors, including manufacturing, leaving fewer skilled people to fill jobs in those areas. This is known as "direct deindustrialization."

  • The Spending Effect

    As money flows to the energy exporters from energy consumers around the world, it increases the amount of spending cash people have. That additional cash increases the demand for non-manufacturing labour -- things such as beauty salons, travel, entertainment -- which in turn sends people into those jobs, and away from manufacturing. This is known as "indirect deindustrialization," or "the spending effect."

  • No Agreement

    Economists are in disagreement about whether Dutch Disease is real, whether it's an important phenomenon, and whether it actually happened in any given economy. Fifty years after the Netherlands' big natural gas find, there is no consensus on whether the country experienced the disease named after it, with many economists arguing excessive social spending was behind manufacturing's decline.

  • The Canadian Debate

    In Canada, Dutch Disease has become a highly polarized political issue. When NDP Leader Thomas Mulcair and Ontario Premier Dalton McGuinty recently referred to what they see as the problem of manufacturing suffering under the weight of a booming oil industry, it prompted accusation of divisiveness from leaders of Western provinces. Economists don't agree either. While a recent study from the Pembina institute argues the phenomenon is real and having a negative impact, others argue the strength of Canada's oil sector is creating internal demand that's offsetting the loss of manufacturing exports. Yet others say Dutch Disease is only a part of the problem, and that other factors -- like offshoring of jobs to developing countries and increases in productivity -- are also to blame for manufacturing's decline.

For evidence, Cross notes that manufacturing output has grown the third fastest among 18 major industry groups since the 2008-09 recession, even outstripping growth in mining, oil and gas.

There is no question Canada's factory sector took a hit during the recession and that jobs have been disappearing over the past 10 years — upwards of 500,000 by some estimates.

But the report disputes that the higher Canadian dollar is a chief reason.

The three manufacturing specialties that took the biggest hit during the recession — autos, clothing and forestry — also contracted in the United States, the report points out. Therefore the reasons likely had to do with structural changes in specific markets rather than the exchange rate, it argues.

The report, being released Wednesday morning, also casts doubt on the relationship between commodity prices and the loonie.

It contends that the main reasons behind the decade-long appreciation of the Canadian dollar was not so much higher commodity prices, although they played a role, but the depreciation of the U.S. greenback and rising investment inflows into Canada.

Cross says rather than petro-dollar, the loonie can be more accurately called as the "Bay Street Buck."

"The recent strength of the exchange rate no longer can be attributed solely to commodity prices, and therefore resource prices cannot be singled out as the source of problems in Canada's manufacturing sector," says Cross, a former chief economic analyst with Statistics Canada.

"If manufacturers in Canada suffered from Dutch Disease after 2002 it was a mild case affecting only a small number of industries."

The theory behind Dutch Disease — a term coined to explain the hollowing out of the Dutch manufacturing sector — holds that a boom in the resource sector causes the currency to appreciate, undercutting exports of manufactured goods. It has some adherents among economists, including the Organization for Economic Co-operation and Development.

But it became a political football in Canada last winter when NDP leader Thomas Mulcair blamed Alberta's oil riches for the some of the economic problems facing Ontario and Quebec.

In a controversial speech in Calgary last fall, Bank of Canada governor Mark Carney largely dismissed the theory, saying that "higher commodity prices are unambiguously good for Canada," and that manufacturing's decline was part of a "broad, secular trend across the advanced world.”

The Cross report acknowledges that the higher Canadian dollar — which continues to trade above parity — has squeezed profit margins for Canadian manufacturing exporters.

"But they have adapted to 10 years of a higher exchange rate and nearly five years of parity with the U.S. greenback by reducing their dependence on exports and increasing their use of imported inputs," the paper states.

"Manufacturers have by far the largest such 'natural hedge' against exchange rate movements of any industry."

Combining the two factors, the report calculates that manufacturing's dependence on the fluctuating exchange rate fell from a high of 27 per cent in 1999 to 18 per cent in 2008.

"The strategies of Canadian manufacturers to adapt to reality of a higher exchange rate have paid off," the report concludes. "Instead of lagging, the volume of manufacturing output rose 12.2 per cent from the second quarter of 2009 to the third quarter of 2012."

Only construction and wholesale trade have had higher growth rates over the period, it said.

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