Finance Committee on Nov. 21st, 2007

[The Chair, Conservative, Rob Merrifield]

I call the meeting to order.

This is our second meeting on the rapid rise of the Canadian dollar and its impact on Canada.

We'd like to welcome the witnesses to this committee. We have two sessions. We are a little bit limited in time because of the bells and votes this afternoon, so we'll try to accelerate the proceedings as fast as we possibly can.

We have with us the C.D. Howe Institute, the Canadian Centre for Policy Alternatives, the Centre for Spatial Economics, Centrale des syndicats démocratiques, and Confédération des syndicats nationaux.

We want to thank you for coming. We will yield you the floor at appropriate times and introduce you by name.

We'll start with Finn Poschmann. The floor is yours. You have five minutes.

Thank you.

[Finn Poschmann, Director of Research, C.D. Howe Institute]

Good afternoon Mr. Chairman and members of the committee.

It's terrific to be here with a new Parliament. Thank you very much for having me.

I will be addressing you in English,

going forward.

So on the loonie, the loonie has been flying high, stalling and falling, and flying high again, and Canadians have been asking non-stop, and are asking me non-stop, what is steering its flight, whether it's a problem, and if it is, what to do about it.

These are huge issues, and pointed ones for manufacturers and others who sell into the world markets and bear costs that are priced in local dollars but whose purchasing has not actually increased at home. This is the classic price-cost squeeze for exporters, one that gets all the tighter as hedges run their course and contracts come due for negotiation.

So what's driving the loonie? The first answer, of course, is the U.S. dollar, which peaked in trade-rated terms--that's from the U.S. perspective--in 2002. I put a figure in front of you, and I believe it's been distributed; thank you very much to staff. Spring 2002 is the peak of the purchasing power of the U.S. dollar in terms of world goods. Since then the U.S. dollar has edged steadily downwards through October 2007, losing roughly one-sixth of its purchasing power in world markets.

This was predicted by many folks, and those predictions were made clearly correct when savers and investors more recently cooled their desire to hold U.S.-dollar-denominated securities. It had been their previous willingness to hold U.S.-dollar-denominated securities that held up the greenback in the face of remarkable stress on the U.S. economy. Consider, if you will, that for calendar year 2007, the U.S. merchandise and trade deficit will come in at nearly $800 billion. So the necessary balance of payments implication is that savers in the rest of the world need to send in about $2 billion a day in capital flows to the U.S. market in the form of portfolio stock and bond purchases or direct investment. As a matter of balance of payments arithmetic, those flows must balance, and in a floating exchange rate environment the currency will adjust until it does. So the first part of the story, of course, is a U.S. dollar story.

It's no surprise that Canada's tight trade alignment with the U.S. should expose our producers to U.S. currency risk. What is new is the pressure on Canada and the world demand for commodities, energy in particular. I have a figure that shows what's happening in energy markets and in commodities excluding energy, and you will see a tremendous recent run-up in energy as distinct from other commodities. My institute's policy analyst, Robin Banerjee, estimated what we fondly call the Bank of Canada equation, which shows that we are indisputably in possession of a petro loonie. This means that after accounting for the interest rate differential between Canada and the U.S. and the price of other commodities, changes in the world price of energy explain most of the price path of the loonie.

So energy prices and investor doubts about the outlook for the U.S. economy explain much of the positive stress on the loonie. There is more, of course. Investors in the U.S. who are doubtful about the U.S. dollar outlook might choose to bet on the oil price as a hedge, right? They're going to buy oil futures. That would exacerbate the upward pressure on the oil price, and on Canada's currency in particular.

How big a problem is all this for the Canadian economy? Clearly, for many Canadians this is a good news story, if not for businesses selling into the U.S. market. There are bright spots, and this goes beyond observing a trade that's been growing well in other markets. StatsCan figures from a couple of weeks back show that Canada's trade with economies other than the U.S. has been growing quite sharply. So not everything is bleak. Of course, we are hugely dependent on the U.S. for our trade market, so that still is, as I say, a huge issue.

The other bright spot I mentioned is that the price of oil is a good hedge on the U.S. dollar. This helps Canadian manufacturers for whom energy is an important input. The rising loonie helps reduce or helps stop energy costs from rising as much as they might have been for Canadian producers. Otherwise, life would be a little more difficult than it is now.

The other point is that the same strong purchasing power abroad makes capital equipment more affordable than otherwise, and this puts in place the conditions for investment in plants and resources that will make our labour force more productive, underpinning future job and wage growth in a non-inflationary environment.

That brings me to my last point--what to do about the dollar. The government and the Bank of Canada's agreement on the inflation targeting framework is an extraordinarily valuable thing. Clarity of purpose helped keep financial markets stable, if not predictable, when the loonie hovered around the 60¢ mark, and so too will it help clarify thinking as we adjust to near parity. We have an extraordinarily resilient export sector, which, while under pressure in many markets, also possesses the skills and tools to respond smartly to that pressure. I have no doubt that they will and that we will succeed in doing so.

[The Chair, Conservative, Rob Merrifield]

Thank you very much. We appreciate that.

We'll now move on to Mario Seccareccia.

[Prof. Mario Seccareccia, Full Professor, Department of Economics, University of Ottawa, Canadian Centre for Policy Alternatives]

Thank you.

I'm very happy to be able to actually speak on my behalf. I was invited by the Canadian Centre for Policy Alternatives, which found that I had done some work in the area. Although not directly connected to the issue of what's happening to the manufacturing sector, I did do some work with a colleague from the American University in Washington on the issue of monetary integration. In that context I would like to be able to say a couple of things with regard to what's happening right now.

One is that clearly there are some underlying factors that are pushing up the Canadian dollar--some have been highlighted by my colleague here--and needless to say, one of the important ones is oil prices.

On the other hand, you see a lot of volatility. The Bank of Canada has been following more or less a kind of pure float, if you wish to call it that. In fact it has not intervened in the foreign exchange markets for the last 10 years approximately. Perhaps that's for good reasons, but I think here's a situation where maybe we should be concerned about it.

As I said, the underlying factors are oil prices, but I think one should be concerned about the speculative elements as well. I'm one who actually supports the idea of a floating rate. I'm not pushing for fixed, or pegged, or further integration, in any sense of the word. I do think there is some concern right now with the volatility. It does impact on decisions, and it impacts on the bottom line for a number of Canadian firms.

In terms of how to address a problem that is of most concern to the manufacturing sector of central Canada, I have some data. At its peak in 2000, we had manufacturing as a share of total employment at around 15.5%; it is down to about 12% right now. It has been going down in a fairly substantive amount over a fairly short period. One should be concerned about what the economists have traditionally referred to as a kind of Dutch disease that is afflicting our industry.

If indeed this sort of Dutch disease is impacting quite negatively on much of our manufacturing sector, which I believe it is, there are certain things that ought to be done. I would like to propose that we have a three-pronged approach on this.

One is that monetary policy is essential here. By that I mean that interest rate policy should be addressed. A lot of people, especially from the manufacturing community, have been yelling and screaming about that. I think it's certainly of concern, especially in light of what I'm going to tell you right now.

If you look at certain indicators, for example, the overnight rate in Canada, which is pretty much under the control of the central bank, when you adjust for inflation, in 2006 the CPI had reached a bottom. It was pretty much like that until about the summer of December 2007, with a gap vis-à-vis the U.S., which is the federal funds rate adjusted for inflation, of about 50 basis points, so 0.5%.

It stayed like that for a while, but since the summer it has shot up, and in the opposite direction. Now we're above the U.S. rate in the order of about 87 basis points. Surely there's some room to manoeuvre here, especially if you look at the inflation rates in the two countries. In the U.S. it's about 3.5% a year CPI. The Canadian rate was about 2.4% in October, for instance, and if you look at the core inflation rate, it's about 1.8%. So surely there's room to manoeuvre.

I would think that something ought to be done. We can certainly bring it down, if anything, within the range of the gap, which is close to 1%. That's something I would certainly ask that we tackle in some way.

In addition to the interest rate policy, the other concern is that we should intervene in the foreign exchange markets. As I said earlier, since 1998 the central bank has not intervened at all. In this case, I think there should be some concern about it and that the bank at least mitigate the fluctuations. We have no control over the international market for oil, and so on, but surely we should do something to mitigate the impact of the dollar's fluctuations on Canadians, and especially in this case when a lot of it is driven by speculation.

The third thing, I think, is on the fiscal side, and that's the last thing I would like to mention here. On the fiscal side, I think we should do something not only in terms of addressing it with a Keynesian-type policy of trying to increase, let's say, domestic demand when our exports are slowing down, but also, at the same time, in terms of the problems with our equalization formula. If you look at what has been happening and the way it's been debated over the last while, we have essentially been arguing that we should exclude oil revenues from that formula—as Newfoundland and Saskatchewan have been arguing in going to court. Now it seems to me that some principle of compensation should be applied if we look at this situation in the context of where oil revenues are rising, that is, in Alberta, where oil prices are shooting up and causing a paralysis of manufacturing in central Canada. That's the point I would like to make.

[The Chair, Conservative, Rob Merrifield]

Thank you very much.

Now we'll move on. We have Robert Fairholm, director of economic forecasting services at the Centre for Spatial Economics.

The floor is yours for five minutes, please.

[Robert Fairholm, Director , Economic Forescasting Services, Centre for Spatial Economics]

In terms of the Canadian dollar and its impact on the Canadian economy, it's important to keep the rise in context. As has been mentioned, commodity prices have been going up and the U.S. dollar has been going down, both of which have forced the Canadian dollar up.

There is reason to believe that the context today is worse for the Canadian economy than it was the last time we had a rapid rise in the Canadian dollar. In part that's because with the rise in commodity prices from an already high level, you have overheated economies in the resource-based sectors of the country, so it's less likely that further growth will come from that. Also, as the Canadian dollar goes higher, the pressure on the manufacturing base will intensify.

While the U.S. dollar has gone down, it has not gone down equally for all currencies. The Canadian dollar is one of those that has risen the most against the U.S. dollar, therefore our relative competitiveness in other markets has deteriorated versus third countries such as Japan. Therefore there is likely to be more of an impact on Canadian exports during this cycle than the last time.

The U.S. economy is also far weaker during this cycle than it was back in 2002-04, when the Canadian dollar ramped up quite considerably. It's well known that the U.S. economy is experiencing a number of problems this time. Last time it was quite robust, and the growth of the U.S. economy sucked in a lot of imports from Canada and helped to offset the negative impact upon Canadian exporters from the rise in the Canadian dollar.

This time we don't have that. We already have an overheated economy in Alberta and in the resource-based sectors of a number of provinces. So you have less of an offset this time than during the previous period.

There is some positive news in terms of some of the changes that have occurred recently. Certainly the mini budget that came out recently will provide some fiscal stimulus, although it will not be sufficient to offset the negative impact from the rise in the Canadian dollar, even after you factor in the rise in the price of oil as well.

One big negative is the volatility of the Canadian dollar. If you're a business person, you have no clue how to factor in exchange rates and resource prices, because they're fluctuating wildly. Volatility has a negative impact upon business investment, and some economic research has illustrated that. Therefore, Canadian companies have this extra pressure on them caused by uncertainty due to the volatility.

There are several key factors that will influence how large an economic impact the rise in the Canadian dollar will have upon the economy. One is monetary policy. If there's no accommodation, you have a larger negative economic hit. If the Bank of Canada eases interest rates, obviously that will have an offsetting influence by stimulating the domestic economy as net exports contract.

The other key thing is the flexibility of the wage-price system. The more inflexible the wage-price system is, the larger the shock and the longer it will take to work its way through the economy.

One policy response is some help for businesses to invest. Certainly the cut in corporate income tax rates is one benefit, although that tax cut is more tail-end-loaded, with most of the fiscal stimulus and tax cuts occurring later on.

One can argue for an investment tax credit or an extension of the CCA holiday to help businesses invest and take advantage of the high value of the Canadian dollar in terms of capital imports.

You should also consider policies that will improve the flexibility of the economy. It's unlikely that they will have a major impact during this cycle, but with the unemployment rate at a 33-year low, certainly anything to lower the full unemployment rate, or NARU, will help today and down the road.

So improving the flexibility of the wage-price system will be helpful. One can do that through geographic mobility--encouraging people to shift from one area to another where the jobs are--as well as inter-occupational mobility. In some surveys we've done, a certain degree of reluctance was illustrated by employers to double-transition between industries and occupations. Given the current pressures on the labour supply, anything that will help companies recognize the qualifications and skills that people have and make those sorts of transitions will be helpful.

In Australia and New Zealand, for example, they have a much more well-developed system of recognizing current competencies and prior learning. Moves toward that type of approach, as well as foreign credential recognition, would be helpful for the Canadian economy in the short, medium, and long terms.

Thank you.

[The Chair, Conservative, Rob Merrifield]

Thank you very much.

I'd appreciate it if we could keep it to five minutes. Our time is very tight in this segment. Hopefully we'll get to flesh out some of your ideas in the question and answer period.

Now we have Claude Faucher from Centrale des syndicats démocratiques.

The floor is yours for five minutes, please.

[Claude Faucher, Vice-President, Centrale des syndicats démocratiques]

Thank you for allowing the Centrale des syndicats démocratiques to express its views on the impact that the value of the Canadian dollar is having on the economy, especially in the manufacturing sector in Quebec.

The rise in the dollar since 2002, and in particular its meteoric rise in recent months, has had major consequences on the manufacturing industry in Quebec. More than 120,000 jobs have been lost since 2002. Within the last year alone, more than 36,000 jobs have been lost. We believe that this is due in part to factors other than the rise in the dollar, but that to a large extent these losses can be attributed to the rise in the dollar.

Generally speaking, jobs in the manufacturing sector, at least the ones we know about in Quebec, have been stable, relatively well paying and motivating for people performing them. We have heard that the economy is doing well in macroeconomic terms, that unemployment is low, as is inflation. In short, against this backdrop, we are led to believe that people who lose their jobs in manufacturing could find an equivalent job tomorrow morning.

That is a standard bureaucratic answer, as far as we are concerned. It can perhaps be defended at the macroeconomic level, but it is a completely different story for the men and women affected by this situation. Just look at forestry, textiles and apparel industries. In cities dominated by a single industry like Montmagny or other municipalities in Quebec, when the company closes its doors, people no longer have resources. We are talking about people who have worked for 30 or 35 years for the same employer and for whom, in many cases, it was their first job when they left school. These are people who have devoted their entire lives to the company by working and earning a living in a dignified way, paying their taxes, and who, despite their good will, are left in the lurch overnight.

It is not true to say that these people will be in a position to find a job tomorrow morning. As for jobs in the industry, people talk about the services sector. I don't think that working at Wal-Mart is very motivating. Above all, these jobs do not pay well. Most jobs that are created are atypical, part-time, and unstable. They provide neither adequate income nor sufficient security for people whose are more focused on their needs and of ways of meeting the obligations of their daily lives.

We think that the Canadian government and the provinces must accept Quebec's proposal to hold an emergency meeting to discuss the situation and to suggest a number of initiatives, such as developing measures to encourage research and development, promoting the strategic repositioning of companies in promising areas, or helping to encourage companies to accept the notion of participatory management in the workplace, an approach we firmly believe in. A company that wants to relaunch itself successfully or guarantee its future must work with the people who are doing the job. We believe that given the current climate, people have no incentive to adopt this approach.

We believe that potential solutions do exist. Job creation strategies must be developed, but we must also think about the thousands of men and women who have no hope of finding a new job when their employment insurance benefits run out, owing to the gap between the training and experience they have acquired over the years and what is required of them in the workplace of today. Some of them will have to relocate, leave their communities, or simply face the fact that they do not have the knowledge and skills required to hold down the jobs available in their regions.

We believe that the government must move immediately to establish an income benefit program for older workers. Moreover, the Quebec Government has already indicated its willingness to participate in such a program. All that is missing is for Ottawa to come on board. We believe that Ottawa has the means to take action, and that it must do so urgently so that people can live in dignity.

That is the crux of my presentation. The government should also honour the commitment it made to assist traditional industries like manufacturing and forestry.

[The Chair, Conservative, Rob Merrifield]

Thank you very much.

We'll now move to Pierre Patry, our last presenter, from the Confédération des syndicats nationaux.

The floor is yours for five minutes, please.

[Pierre Patry, Treasurer, Confédération des syndicats nationaux]

Thank you very much, Mr. Chairman.

I want to start by pointing out that the Confédération des syndicats nationaux is a union organization representing 300,000 workers, mainly in Quebec, in all industrial sectors, including manufacturing, which is currently hard hit by the rise in the dollar. The CSN represents people in all sectors, be it paper, forestry, metallurgy, agrifood, or tourism.

We want to thank the committee for its invitation, although we only officially received it last Monday. That is not much time to prepare a comprehensive analysis of the situation. Having said that, the CSN does want to provide input to the government on this issue.

As others before me have said, if we take a global look at the macroeconomic situation, judging strictly from the numbers, things are going well. Employment is up and the unemployment rate is relatively low. However, if we take a more in-depth look at the issue by sector, we see, at least in Quebec, that the manufacturing sector has taken quite a hit. Since December 31, 2002, Quebec has lost some 135,000, or 20%, of the jobs in this sector.

Twenty-one thousand jobs have been lost in forestry alone. It's a disaster considering that in Quebec, 100,000 people in 240 towns and cities work in this sector. Often, towns only have one industry.

What's more, Chinese imports to Canada have gone from $12 billion to $32 billion over five years. The trade surplus, which was $7 billion in 2003, has turned into a trade deficit of $15 billion in 2007. In light of these facts, the situation is not at all rosy.

I am going to quickly talk about monetary policy. Our main concern, as was the case for the previous speaker, is employment and the factors that can adversely affect it. In our estimation, it is clear that the Bank of Canada must take action, specifically by lowering interest rates. It is all well and good to fight inflation, but inflation is currently well under control. The inflation rate in Canada is even lower than it is in the United States. But as it happens, maintaining higher interest rates contributes to the rise in the Canadian dollar. That has repercussions on manufacturing, and thousands of people are losing their jobs.

We feel that the government must use its budgetary, fiscal and financial policies to take action at the same time as the Bank of Canada. In this regard, the measures announced in the Conservatives' most recent economic statement are inadequate, in our opinion. Reducing corporate taxes from 22% to 15% over a certain period of time is laudable, but companies that do not make a profit do not pay taxes anyway. Overall, apart from pharmaceutical companies, the manufacturing sector in Quebec is not turning a profit.

Instead, businesses need other kinds of assistance, like investment and employment support measures. We are thinking mainly about loan and loan guarantee programs that could be beneficial for companies. At present, the high dollar may encourage corporate investment if businesses are purchasing their equipment abroad, but there again, they need funds to be able to do that.

We feel that the Government of Canada should support and complement what Quebec is doing, for example. Quebec is providing tax assistance to resource-based regions with a view to helping them promote secondary and tertiary processing, of which there is unfortunately too little in Quebec.

I also want to address the issue of research and development. Statistics in this area show that Canada lags behind the OECD average for comparable member states, while the private sector is also lagging behind in terms of research and development in OECD member states. The federal government should help businesses so that more research and development is done. Existing tax credits that should be refundable is one idea that comes to mind. Even companies that are not turning profits could at least benefit from that. We would also like the government to make more expenditures eligible for tax credits, including costs associated with obtaining a patent as well as human resources training costs. These initiatives would help to increase productivity and help people hold on to their jobs.

As I said earlier, the CSN is primarily concerned with job losses in the manufacturing sector. The forestry industry has been hard hit by job losses. Some 20% of our members working in this industry have lost their jobs. I provided you with some overall numbers a little earlier.

Finally, I would like to briefly address two other issues. Providing transition measures to help people move into other jobs is a good idea, but unfortunately, some people fall through the cracks. We feel that the government must take steps to improve the employment insurance system, namely by increasing benefit levels, improving and facilitating eligibility for employment insurance and extending the benefit period.

Moreover, we feel that specific measures must be adopted as part of an income support program for older workers. ALthough we agree with the most recent programs put in place by the federal government to promote the transition of older individuals to the workplace, many of these workers do not have the training they need to successfully make this transition. Measures are needed to bridge the gap between employment insurance and eventually, pension benefits. I would point out that an initiative on this level would cost the federal government only $75 million per year, whereas it has announced a $10 billion surplus for this year. The federal government has the wherewithal to act on these matters.

[The Chair, Conservative, Rob Merrifield]

Thank you very much.

We'll now move on to the questioning part. We'll start with the Liberal Party, with Mr. McCallum. We have six minutes in this round, and I think we can get it done in time.

Go ahead.

[John McCallum, Liberal, Markham—Unionville, ON]

I want to thank all of the witnesses for coming.

I would like to start by asking everyone the same question.

It's a very simple question. I think it's fair to say that if the currency stays at the current level, the job losses we've seen in industries that are sensitive to exchange rates will get bigger. From an economic point of view, I think it's clear that currency appreciation has a significant effect, but it takes one or two years to be fully played out because of lags of various kinds.

Very quickly to the three economists, beginning with Robert Fairholm, do you agree with that; and do you have any numbers, or approximate numbers, to add to it?

[Robert Fairholm]

Yes, I agree with that. It takes a while for the full impact of a rising Canadian dollar to feed through the economy and have its peak impact on output and jobs. We did a study for Industry Canada a few years ago, which presumably you can get access to, that examined the previous rise in the Canadian dollar, looking at increases of 10% to 15% or so, and the peak impact came two or three years after the run-up in the currency.

[John McCallum, Liberal, Markham—Unionville, ON]

So in the present experience, that would mean that the job losses we've seen in the last six months, say, are quite small compared with what we'll see in the next 12 months if the dollar stays where it is.

[Robert Fairholm]

Exactly.

[John McCallum, Liberal, Markham—Unionville, ON]

Okay.

Do any of the economists disagree with that?

[Prof. Mario Seccareccia]

I would argue also that on the price side there are some benefits there, over time.

[John McCallum, Liberal, Markham—Unionville, ON]

I know there are benefits, but it's a narrow—

[A voice]

The short-term impacts are negative.

[Prof. Mario Seccareccia]

Sure; absolutely agreed.

[John McCallum, Liberal, Markham—Unionville, ON]

That takes me to our two guests representing the unions. Are you also under the impression that the situation will worsen over time if the dollar maintains its current value?

[Pierre Patry]

The situation is already disastrous for the entire manufacturing sector, because the dollar has been on the rise for five or six years. Its value has increased some 40% over the American dollar. Many job losses have already occurred in certain sectors.

However, there are some areas that we have yet to touch on. We represent people in the tourism industry. The value of the Canadian dollar has clearly been increasing against the US dollar for a number of years. Now that the Canadian dollar is stronger than the US dollar, we are very worried about the negative impact this may have on this industry a year or two from now. That is why action must be taken right away, namely through monetary policy. We also need to bring in support measures for workers who lose their jobs, through the employment insurance system and income programs for older workers. This is absolutely essential. At the same time, by doing this, we can take advantage of the current situation to encourage investment in businesses, because the dollar will remain high for some time. So then, the government needs a comprehensive short-, medium- and long-term strategy.

[John McCallum, Liberal, Markham—Unionville, ON]

That's good, thank you. I fully agree with you, action must be taken. I was simply trying to establish that the situation will worsen if nothing is done.

I'd like to switch the topic now, to something that I think Mr. Poschmann and I may agree on.

On the question of the current monetary system of inflation targeting versus a fixed exchange rate or a monetary union, I would argue that a peg is not really feasible. It has to be something stronger, like the euro. From time to time, when the dollar is very weak or volatile or high, this call for a monetary union re-emerges in Canada. Just yesterday, a well-respected individual, Roger Martin, started talking along those lines.

To Finn Poschmann, whether for economic reasons, sovereignty reasons, or both, which system do you prefer?

[Finn Poschmann]

Clearly, Mr. Chair, I'm going to have to have a talk with Roger.

The floating exchange rate, or inflation targeting, is a monetary order that's been working very well for Canada. The question of a fix immediately prompts you to ask, “At what level?”

This actually would go back to the question you asked before, about if the dollar stays where it is. Well, it's not going to. If you're doing your modelling on what's going to happen to jobs, look, did you want to do that modelling at last week's $1.10, or this week's or yesterday's exchange rate, or at this afternoon's exchange rate, when it's a cent lower?

So we have to be cautious about making a lot of assumptions--

[John McCallum, Liberal, Markham—Unionville, ON]

No, I'm assuming that the dollar stays where it is. That was the premise of the question.