Channels Causing The Dutch Effect Economics Essay
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Assignment Title:
Assignment 2 "Dutch Disease"
Course Code:
RSM
Course Title:
Macro Economics for Finance Professionals
Professor Name:
Peter Pauly
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TOPIC: DUTCH DISEASE
What is meant by the term? Explain in detail and outline the channels that could cause such an effect. Examine the evidence for Canada. What are the arguments for or against the proposition that the country has experienced a period of Dutch Disease
The Dutch Disease gets its name from an economic phenomenon that had been observed in Holland. The discovery of natural gas in Holland led to the slump in other sectors like manufacturing. Essentially, Dutch Disease is the recession that hit other sectors when one industry dominates, or increases its exports. [1] The term was invented in 1977 in an article in The Economist and later the Economic model to explain Dutch Disease was developed by W. Max Corden and Peter Neary in the 1980s. According to them, the parties involved included the non-traded goods sector and the traded goods sector. Of the traded goods sector, one sector is booming while another was under-performing that could be harmful to an economy such as Canada.1
Dutch Disease defined…
Dutch Disease can be described as a concept that explains the possible relationship between the increase in exploitation of natural resources and a decline in the manufacturing sector. [2] The increased revenues due to the increase in natural resources will result in a large inflow; eventually leading to currency appreciation, making the country's other products less price competitive on the export market. It would also lead to higher levels of cheap imports and industries apart from resource exploitation get moved to cheaper locations, leading to deindustrialization. [3]
Channels causing the Dutch Effect…
There is evidence in Canada, that resource industries have grown (led by expansion in the petroleum sector) and most of their output is exported in a raw or barely processed form. Additionally, the resulting record high commodity prices have led to an appreciation of Canada's exchange rate. This may have in part been causing the squeezing out of the manufacturing sector, by the macroeconomic side-effects of the resource boom. [4] This resource dependency is also not considered to be natural. A number of key economic indicators testify to the effect that Canada's economy is heading in a different structural direction, these are: [5]
The strong expansion of the natural resource production and export, especially petroleum;
A sharp decline in manufacturing output and employment. Approximately, 600,000 Canadian manufacturing jobs have disappeared since the turn of the century;
Dramatic appreciation of the Canadian dollar. It has risen 60% in value against the US dollar in the last decade;
Deterioration of the overall trade balance. The growth of resource exports has been inadequate to offset the decline in other exports (such as manufacturing, tourism and services); and
A shift from tradable to non-tradable sectors, thus exports constitute a significantly smaller share of the total production.
The dollar is the most important channel through which the 'Dutch Disease' symptoms are felt.
Evidence for Canada…
Recently NDP Leader (Thomas Mulcair) and Mark Carney (Governor of the Bank of Canada) have strongly debated about the existence of Dutch disease, [6] with Mulcair supporting the existence of the disease and Carney rejecting the existence of the disease. Economists are also divided on this issue; Jim Stanford and Luc Vallee support the view point of Mulclair, while economist such as Stephen Gordon and many others have refuted this.
As stated previously, Canada's currency has risen 60% in the past decade. This is having a huge impact on exports making auto-plants uncompetitive and thus hammering manufacturing especially in Ontario and Quebec. However, studies have found that there was a negative relationship between Canada and US exchange rate and output. [7] Therefore, the Institute for Research on Public Policy claims that Canada has a mild case of Dutch disease. [8] The Organization for Economic Co-operation and Development (OECD) report stated that the run-up in commodity prices was leading to an uneven economy in Canada. [9] Resource rich provinces such as Alberta, Saskatchewan and Newfoundland & Labrador have prospered while others had fallen behind, partly because the commodity boom had strengthened the Canadian dollar, hurting the manufacturing and tourism sectors.
An OECD report [10] had found that the manufacturing sector had shrunk to only 12.6% of the total value added, from a peak of 18.6% in 2000. Furthermore, its share of employment had fallen substantially from 15.2% to 10.2% or approximately 500,000 jobs. [11] The growth in Alberta, Saskatchewan and Newfoundland & Labrador have enjoyed the largest per capita income gains during the past decade, with the growth in the manufacturing centres of Ontario & Quebec being sluggish. These regional grown disparities are an evidence of divergences in sectoral activities. This confirms that Canada is indeed suffering from Dutch Disease.10
However, Carney states that even though some people think of it as a curse, it is a simplistic argument and claims it to be wrong in the end and commodities are used to prove the point..11 The following reasons were given by Carney as why he thought it was simplistic:
Numerous factors influence our currency - It is true that Canada is a net exporter of commodities while our main trading partner, the US, is a net importer. This causes our respective terms of trade to move in the opposite direction in response to commodity-price changes. Consequently, the Canada-US exchange rates tend to appreciate when the global commodity prices rise. Furthermore, the Bank of Canada estimates that 40% of the Canadian dollar appreciation since 2002 is due to the multilateral depreciation of the US dollar.4
In addition, Canada has a variety of attributes that make it an attractive investment destination, including sound public finances, resilient financial system and a credible monetary policy. These attributes limit the downside risk associated with Canadian assets, making Canada a safe haven in a risky world. The evidence for this is seen in the correlation between the Canadian 10-year yields and the global equity prices, which suggests that money flows into Canadian bonds, in response to increases in perceived risk.4
Commodity Prices will subside - Carney states that the argument of Dutch Disease is based on the assumption that commodity prices will subside. He states that this is unlikely at a time when emerging economies are rapidly urbanizing.11
Global Decline in Manufacturing - A decline in manufacturing has been observed across the advanced industrial world, reflecting globalization and technological change. Market carnet that approximately half of the rise of the Canadian dollar on exchange markets in the last decade could be attributed to higher natural resource prices.11
Shutting down Oil Sands - the Dutch Disease diagnosis would require Canada to lower the value of the loonie. In order to do this, Canada would have to 'shut down the oil sands and abandon the resource wealth, have high and variable inflation, run large fiscal deficits and diminish our financial sector. These actions would weaken the Canadian dollar, but would also weaken Canada.11
Mark Carney therefore concludes that the symptoms we are seeing are those of structural changes in the global economy, and not of the Dutch Disease to which Canada has to adjust.
How could, in your view, an active government reduce the incidence of 'Dutch Disease' or at the very least mitigate its effects? How would these regional differences manifest itself in an environment at fixed exchange rates?
In essence, Dutch Disease, DD is due to a large amount of spending generated from the sale and taxation (taxes and royalty fees) of profit and of revenues a natural and investment driven by a discovery, a newly viable of a resource in a specific country or region, all associated with effects are due to the sudden injection of funds into one region which reduces the competitiveness of the nation as a whole. All associated solutions have to do with the redistribution of the benefits across the industries, saving or creating a leakage of the excess funds. To achieve such tasks an active government may enact a number of policies and activities to reduce or mitigate the effects of "DD".
A resource boom usually occurs in 3 stages (these stages can overlap): exploration, development and operation & profit taking [12] . Depending on the specific dynamics of the nation the government could enact a number of policies that would allow for the stabilization of the economy, therefore, though not eliminating DD, but managing the effects of this phenomenon.
In the first stage of the resource boom, relatively low risk of DD at this stage, the government gives the right for exploration to the private sector or sets up a government owned entities to conduct the exploration [13] . At this stage, depending on the targeted resource, exploration companies will use limited amount of funds, relatively small compared to the next stages. Local government, in most countries (does not include countries such as Iraq, officially the Oil Ministry, a Federal entity has the authority to provide such rights) in return for fees is applied to and collected by the local government (i.e. a sudden injection of funds available to the local governments). The following are the expected symptoms that should occur during this period:
Inflation: The local governments would earn fees from providing exploration rights from the private sector. Depending on what the local governments do with the funds (i.e. save or spend the funds) the following are the anticipated results:
If spent, should include a small increase in the level of inflation. At this stage, exploration companies are conducting their tests to identify financially viable opportunities. As the companies already exist, probably in the resource region, there should not be an increase in the labor demand;
If saved, there should be limited to no effect on the local or country's economy. A small increase in inflation could occur due to the investment made by the companies.
Currency appreciation: as more reserves are discovered currency movements/appreciation is expected and real appreciation should be observed at this stage. Though we do not expect a significant increase in the value of the currency.
In the second stage, high risk of DD, development of the financially viable resources, many scenarios exist with their own distinct effects on the level of impact of the phenomenon, however we will limit the discussion to 2 scenarios [14] - A 100% government owned entity develops the resource (could also take the form of Build Operate Transfer (BOT) or a Build Own Operate Transfer (BOOT) agreement is made with the private sector, ensuring the ownership of the resource remains with the government or is returned to the government in the future) and second a Private Public Partnership (PPP) or a Private ownership of the assets (foreign or locally owned).
A large amount of funds are invested to develop capacity. The main issue associated with the ownership structure of the firms is that it defines the entities that would invest to develop the resource. During this specific period the effects of the DD begin to manifest themselves. The following should be observed at this stage:
Structural unemployment:
In the scenario that a 100% local government owned entity develops the resource. The local government will have to reallocate finances to the firm/s to develop the resource. Depending on the level of wealth of the government, this could cause a temporary, resource region specific, structural unemployment. For example, the province or state will have to redeploy its resources from services or increase the tax rate to ensure the availability of sufficient funds for the development. However, most governments, wishing to maintain the ownership of the assets and mitigate the local structural unemployment issue would enter into agreements with private entities such as BOT or BOOT. Depending on the agreement, this strategy would not cause any significant resource reallocation and thereby avoid the local structural unemployment that would have occurred otherwise. Non-resource rich regions would experience some highly trained employee migration as demand for highly qualified employees increase.
PPP or privately owned entities would invest heavily to develop the capacity. Companies would begin to source high trained employees from around the country to meet their employment needs.
Inflation: depending on source of the equipment acquired the following should be expected:
If capital equipment is sourced internationally [15] : local and federal governments receive additional revenues due to the import taxes (in addition to other government fees that could and do get levied);
If capital goods sourced locally: a sudden surge in demand for capital goods would add to the inflation pleasures. Additional liquidity is available in the market which would be reflected in high demand and prices (the level of intensity is dependent on the economy and if the economy is operating at the efficiency frontier or below it);
Labor: A significant migration from different sectors, specifically the traded goods. Causing an increase in wages (i.e. an increase in the cost of inputs for the traded goods), therefore a reduced levels of profitability;
Appreciation of local currency: at this stage more pronounced appreciation in the currency and pressure on manufacturers increase as imports are more attractive and exports less attractive. Cost cutting measures are significant (e.g. reducing head count, R&D expenditure etc.).
The Final stage is the operation and profit taking, the development stage is complete and operations and profits taking occur. Again depending on the agreements initially agreed upon and the ownership structure, local governments are generating significant funds from income taxes (corporate and individual), royalty fees etc.
The following are the effects expected effects of DD on the non-resource regions:
Structural unemployment: Increased demand for highly qualified employees would ensue coupled with significant increases in wages. Other regions would suffer as they would lose their labor force to the resource region. Migration of employees coupled with losses in the manufacturing industry would reduce non-resource regions income and corporate tax.
Currency is highly correlated with the resource prices. Additional appreciation would put additional pressure on manufacturing. Further cost cutting measures are implemented. The most devastating/long term damage to the manufacturing will be caused by the reduction in the R&D expenditure, as companies will have to catch up after the boom with the rest of the world. Unemployment increases due to companies/industries becoming less competitive and reducing headcount;
Deterioration of exports due to currency appreciation (as mentioned in the earlier section 500,000 jobs were lost);
A shift in the resources of the economy from traded goods to non-traded goods;
Manufacturing have been defined as high growth, as compared with resource industries [16] continues to decline with the whole economy growing at a low growth rate.
DD Mitigation Methods
As mentioned earlier, the main methods to mitigate the effects of DD is to increase savings/leakages and redistribution of wealth across the country.
Shift to a fixed exchange rate (against the US dollar for Canada, 80% of international trade is with the US - a global currency index could also be used similar to the one used in Kuwait):
In the past decades the Canadian Dollar appreciated from CAD 1.56 to CAD 0.9978 [17] (38% appreciation) against the US Dollar, though the change in the currency is not limited to the resource boom the decline in the American economy did weaken the USD, there would be a strong argument to fix the exchange rate with the USD to limit the effects of the exchange rates on sales of exports and limit the benefits experienced by imports.
Advantages: In a fixed exchange rate environment, the increased spend generated from the resource boom would generate increased demand. This would be followed by an increase in the price of input, mainly due to an increase in the prices of labor and raw materials (driven by increases in cost of labor-could be mitigated if the raw material is a commodity and is priced on the international markets or if it could be sourced internationally cost effectively). Disadvantages: The advantages to the manufacturing sector are easy to understand, however fixing the exchange rate to the USD would limit the central bank's ability to manage the monetary policy for the country (i.e. somewhat mimic the Euro Zone issue) [18] . In this scenario the central bank will have to maintain the short term interest rates to be in line with the US Fed rate to ensure that an arbitrage opportunity does not develop. Managing a fixed exchange rate would be difficult as the nominal value of the currency is linked to the commodity prices. Canada failed to maintain a fixed exchange rate in the 50s and 60s [19] .
The effects of the fixed exchange strategy would be different for the Resource and non-resource regions:
Resource region: a fixed exchange rate would destabilize the revenues generated from the resource. Since the currency and the price of the resource are correlated to each other, in a free exchange, an increase in the price of the resource would be coupled with an increase in the nominal value of the currency (changes in revenues are limited). However, in a fixed exchange rate scenario, a significant increase in the price of the resource would significantly increase the revenues and vice versa [20] ;
In the non-resource sector, the effects of the appreciation in the currency does not materialize, though the cost of inputs would still increases, the increased local demand and the stabilization of the currency could more than offset each other (assuming that the product could still be produced profitably and excess capacity exists). In this scenario, non-resource regions would benefit from the resource boom.
Creation of a sovereign wealth fund (SWF):
Local and Federal Governments invest the revenues generated from the resource boom in a SWF with an international investment mandate (acts as a leakage in the economy). The country would, in theory, manage the excess wealth/funds in the economy by investing them internationally by creating an SWF entity.
Advantages: Investing Funds in an SWF would increase the supply of local currency on the international markets which would cause the devaluation of the currency, reducing the effects of DD.
Disadvantages:
The main weakness of the SWF strategy is that the majority of the wealth generated in a resource boom is generated at the provincial level (i.e. as the resources are owned by the citizens living in the province/region, the majority of the rents are collected at the provincial level, a relatively small amount of funds will be generated at the federal or national level - approximately 33% of amounts generated at the provincial level) [21] . Therefore the creation of an SWF at the provincial level would have a more significant impact on the DD effects. However, as experienced in Canada, Provincial Governments tend to reduce their local taxes and increase spending on infrastructure and services province to attract industry to the province.
Another issue of the SWF, rarely discussed and is related to the previous point, is democracy. Since democratic countries tend to have term limits for elected officials, local and federal governments would have the incentive to spend revenues generated from resource booms during their tenure. The boom would create localized wealth which in turn would generate future votes for the party. The creation of SWF, in essence a leakage from the economy, is difficult to justify as the benefits will not realized for long periods of time. Because SWF is perceived as a leakage, it might even be considered to be politically incorrect by the average voter, especially if jobs have been lost due to the resource boom.
Taxes, Royalties and Subsidies:
A resource boom, by its nature, has is time limit, the most devastating effect of DD is the decline in R&D so once the boom subsides the manufacturing industry still requires some time to catch up with its competitors (note, knowhow could be purchased to shorten such a period). To best manage this issue the government could use the some of the tax and royalty revenues generated from resources industry to subsidize R&D, reduce taxes and invest in the infrastructure available in non-resource regions to maintain their attractiveness to industry. The additional investment in the troubled regions should reduce labor migration, limit structural unemployment and encourage the technological advancement of the industries [22] .
Too many negative factors are associated with this strategy the following is what we perceive as the most significant:
Costly: as mentioned in the SWF section, the province generates the majority of the revenues, rents, from a resource boom, a federal program used to encourage manufacturing in other regions could require increased taxes or government debt [23] ;
Political issue: once a change in the tax code or a subsidy is provided it is difficult to withdraw in addition to direct subsidization is usually defined as the breaking of international trade agreements.
Market efficiency is bypassed: the migration of resources, financial and labor, is not necessarily a temporary issue [24] (interference from the government/s would delay of the inevitable).
It is difficult to decide which industries should be incentivized or allowed the decline, political ramifications and the associated costs play a major role in the decision making not long term financial viability of the industry (e.g. US automotive industry);
Subsidization or tax restructuring reduces the efficiencies of industries.
Increase Temporary worker immigration
The federal government could encourage temporary immigration (temporary work visas) to limit the effects of the labor migration to the resource rich regions. One of the main effects of a resource boom is a shortage in labor supply created from an increase in demand for trained labor in the resource rich region. The use of temporary immigration would fill the needs of the booming region without negatively affecting the non-resource regions availability of labor. This strategy should reduce the expected wage increases and maintain the manufacturing sectors ability to source highly qualified employees (note, as an immigrant, we will not list any disadvantages) [25] .
Maintain ownership of resources at the Federal Government level
Federal Ownership: A potential solution would be to maintain the ownership at the Federal level, the funds generated would be invested in an SWF for the benefit of the nation rather than limiting the benefits to the province.
Advantages: a better distribution of wealth across the entire nation, allowing for investment in SWF and infrastructure and finance subsidies to protect the manufacturing sector.
Disadvantages: the owner of the resource is the province, an agreement between the province and the Federal Government is required to ensure that the province is willing to allow for the development of the resource (i.e. some form of preferential distribution of wealth to the province). If such an agreement is not found, the province would either not wish to develop the resource, or in extreme cases the separation from the country (e.g. South Sudan, we are aware that there were many other factors that went into the separation, however the perceived misallocation of funds from a local resource was one of the main justification for the separation) [26] .
Increase international trade agreement
The federal government could encourage exports by entering into bilateral international trade agreements to increase international trade.
In conclusion, all or none of the above mentioned mitigation strategies could be used. No one strategy would eliminate the effects of DD. The best way to manage DD seems to be create saving or a leakage entities to allow to soften the effects of DD.
Somewhat related, observers often voice concerns about foreign direct investment in resource industries (and other industries). What are those concerns and are they justified, in your view? Can you see any linkages in between foreign ownership of Canadian companies and 'Dutch Disease'?
Foreign Direct Investment defined...
Foreign Direct Investment (FDI) is the purchase or construction of tangible assets in one country by firms from another country. [27] According to International Monetary Fund, FDI is defined as "when one individual or business owns 10% or more of a foreign company's capital" [28] .
Global Position of Foreign Direct Investment and how it's evolving…
A brief overview on the global position enables to understand the effects of economic changes on the direction of FDI flows. Foreign Direct Investment is an important characteristic of a globalized economy and appears to be the least volatile than other forms of capital flows. Global FDI has almost increased 4 fold in last 15 years increasing from $390 billion in 1996 to $1,524 billion in 2011. The growth in FDI has been greater than the growth rate in world GDP, and reached a peak of $1,975 in 2007 after which it has shown some decline in past 4 years. The composition of FDI flows has also changed since 2007 where the share of developing countries has increased from 29% to 45% whilst FDI to developed countries as a percentage has declined from 66% to 49%. [29] .
Concerns on Foreign Direct Investment Justified…
There has been theoretical and empirical evidence that suggest inward foreign direct investment promotes growth. However, recently there also have been studies that have shown that foreign direct investment also has some drawbacks. [30] Detailed examinations of each of the highlighted concerns propose that these are valid arguments if considered in isolation and empirical relevance of these risk remains to be verified, the potential risks do appear to make a case for taking a distinct view of the likely effects of FDI. Further, just like not all businesses create value and all domestic investors would serve the best interests of the country, it is the laws and regulations that govern those investors that are likely to determine their impact in the host country and most of the voiced over concerns will not be visible as serious problems if correct framework is implemented. Perhaps to an extent, the level of development of a country may need to be cautiously looked at to understand if foreign direct investment may affect the host country in context of the dynamics of that country such as if it's a developed, developing or transitioning economy. Bosworth and Collins have concluded that the benefits of inflows of FDI for a developing country are sufficient to offset the risks of free capital flow across border.
Some identified concerns and their reasoning…
Strategic Interests: Foreign ownership of industries especially resource industries or some other sectors that are of strategic importance or by specific countries may expose the country to a security threats. Concerns on the exploitation of natural resources of a host country in order to get short run gains and profits have been in existence since 17th century colonialism. It would be interesting to read a relevant quote of Dr Laura Dawson in this regard and she says "we wouldn't allow North Korea to acquire a Saskatchewan uranium mine"
The recent concerns on this aspect have been severed due to the growing FDI flow from sovereign wealth funds and state-owned enterprises leading to study and improve the legislation frameworks on international arbitration. Further, it's also being argued that increased Chinese natural resource investments may influence by "locking up" the world's resource base [31] . Finally national security concerns might also arise when ultimate investors are not known and an indirect foreign direct investment has been made.
Strategic interests are not restricted to national security alone. It also refers to the access of foreign direct investors on the intellectual property assets of the host country. The examples are BHP Billiton's acquisition of Saskatchewan's Potash Corporation last year in Canada or a potential acquisition of stock exchange of a country. [32] We believe in the optimistic view of the observers who disregard that Canada (or any other country) should guard its domestic Intellectual property with a potential risk that it would never be reproduced but agree that in a high technology world, you have to embrace such challenges and be ready to produce such products on a continual basis.
Profit Repatriation and Long Term Capital Movement: Some critics have highlighted that once the foreign direct investment becomes profitable, the profits are then repatriated back to the parent country which may create pressure on foreign exchange reserves of the host country. However, we believe that as excess profits in industries get back to the shareholders only in the maturity stage of business, the economic benefits during the introduction to later growth and early maturity stage through job creation and increased productivity are likely to outweigh the outflow of capital at the later stage. Further, the increased wealth with investors would encourage them to invest further in the host country creating more jobs and prosperity. However, in the case of an FDI establishment that has engineered a transaction through reversing its investment by domestic borrowing against its collateral (excessive leverage) and lending back the money to the parent company, it is true that the advantages of FDI would be very limited in that case.
Threat to local industry growth: This concern is atypical for developing countries where foreign direct investment may disrupt the growth of local industries. As multinational corporations are likely to have greater access to financial capital, best talent, advertisement resources, arbitrage opportunities due to spread out operations across countries and most importantly economies of scale, it would be difficult for domestic manufacturers to compete. However, this argument seems invalid in today's global world where it would be detrimental in the long run for the competitive position of the domestic industry if it hid behind the investment barriers.
Income inequality: A weak argument against Foreign Direct Investment has also been laid on the grounds that multinational corporations due to their ability of excessive advertising and premium pricing power encourages incorrect consumption patterns. Also by creating few high paying executive jobs, and diverting resources towards manufacturing of sophisticated products and use of capital intensive techniques in a labor intensive economy, they are likely to create imbalances in the economy. We do not believe that such arguments would have any economic basis as disparities in the income distribution are a function of a number of policy directions and hence could be easily mitigated.
Financial crisis and FireSaIe Situation: Krugman (1998) have questioned the taking over control by foreign corporation in the midst of a crisis due to the power of cash and not because of special competence and believes such firesale of domestic firms and their assets represent a burden to the afflicted countries, over and above the cost of the crisis itself.
Assymetric information: FDI enables foreign investors get access to superior information about the companies they own and can use this information to sell unprofitable portions of the firm to domestic investors who lack this information.
Lobbying: in the context of developing countries, this concern has shown empirical evidence where large multinational organizations have invested in countries whose GDP is lower than their revenues. This has enabled them to influence the host country's politics and take control over economic policies. Recently these concerns have also been voiced over in Canada where it is assumed that excess foreign investment may lead our economic indicators at the mercy of these investors.
Linkage between foreign ownership and Dutch disease
The Canadian resource sector has become a major source of export revenues and foreign investment which has contributed to the upward pressure on the dollar and dampened exports of manufactured products. However, for a linkage to exist between foreign ownership of Canadian resource assets and the structural shift away from manufacturing towards services, the decline in manufacturing must be directly attributable to foreign investment in the resource sector. For this phenomenon to be true, foreign capital flows in the resource sector will be exclusively responsible for an appreciation in currency of the host country thereby rendering export of manufactured goods uncompetitive and shifting factors of production towards the more profitable resource sector. The decline in manufacturing may be acute enough for it to be non-recoverable and leave the economy vulnerable to price volatility of commodities. A closer examination shows that there are several other factors at play that are equally responsible for the re-allocation of resources in the Canadian economy. The structural shift is partly due to the resource boom and part of it is being driven by demand for services, technological changes and competitive pressures home and abroad. Moreover, this reallocation in resources is a sign of flexibility and a source of strength for an economy rather than disease.
A broader view of the global economy shows that loonies strength is not solely due to the increased demand for Canadian oil and resources. Other factors besides the demand for oil are pushing up the value of dollar. With increased global economic uncertainty largely due to the looming fiscal crisis in the US and an existential threat to the Euro, Canada's fiscal strength provides a safe haven for international capital. Bank of Canada estimates that about 60% of appreciation in Canadian dollar over the past decade is due to factors other than the US dollar weakness and commodity prices. This is reinforced by the fact that Canada 10 year yields have fallen at the same time as global equity prices suggesting a positive correlation between Canada bonds and the increased perceived risk of risky assets [33] . Moreover, in the short term, higher interest rates make the Canadian dollar-denominated assets more attractive to foreign investors thus further driving up the value of loonie [34] . In short, while commodity prices are the primary drivers of appreciation in Canadian Dollar relative to the US currency, other factors have contributed significantly to loonies rise.
Furthermore, stronger Loonie is not the only factor contributing to the decline in manufactured exports and the underlying structural shifts are more wide spread. The significant productivity gains in services, mainly due to technology, over the past 30 years have led to a general decline in manufacturing across the industrialized world. Hence Canada is not unique in this sense. Not surprisingly, manufacturing sector's share in employment and output has declined from 15.2% and 18.4% in 2000, to 10.2% and 12.8% respectively, in 2011. Conversely, the share of service sector in employment and output has increased from 74.2% and 66.1% in 2000, to 78% and 71.6% respectively, in 2011 [35] .
Furthermore, the manufactured exports have been losing ground, particularly in the US, to more competitively priced products from the developing world. While China and India have become the new power houses of manufacturing, higher value added services and manufacturing remain the principal domain of advanced economies. The strength in Loonie has certainly added to this decline in manufacturing but so has the dismal productivity gains and lack of innovation in the manufactured goods industry in Canada. Productivity in Canada has risen at a sluggish pace of 1% over the past decade, one of the slowest in the industrialized world [36] . Manufacturing sector has seen the worst decline in productivity growth, dropping from 4% to 0.1% [37] . Moreover, Canadian businesses are seriously lacking in innovation which is evident from the fact that there are very few global Canadian brands [38] . This lack in innovation may be the result of lower emphasis on research and development. At present, business R&D stands at just 0.9% of Canada's GDP [39] . Whatever the cause may be, if Canada is to compete effectively in the global economy then Canadian businesses and manufacturers in particular, will have to learn to be more innovative and productive. This becomes even more critical in an environment of rising dollar. Canadian manufactures will simply have to compete on the basis of innovative product lines and technologies and higher productivity levels than ever before.
Lastly, the structural adjustments are unavoidable as capital, domestic or foreign, will continue to drift towards more profitable sectors of the economy. The re-allocation of resources, if unhindered, will only promote efficiency and competitiveness of the industry with significant spill-over effects in other parts of the economy. In other words, the resource boom will lead to increased demand for equipment parts and supplies and services like engineering and design, thus distributing income and wealth effect across the economy. The negative effects of a stronger dollar are partially offset by cheaper imports of equipment and technology that boost productivity [40] .
In conclusion, the decline in manufacturing has very little to do with foreign ownership or foreign capital flows as the re-allocation of resources in an open economy is purely a function of the underlying profitability of a sector. The decline in manufacturing is only partially explained by rising commodity prices and other factors have a major share in its decline. The structural changes in the global economy over the last three decades, along with sluggish productivity growth in the manufacturing sector and lack of innovation are some of the major reasons behind this decline, apart from commodity prices.
