The Canadian Dollar Above Par: Who’s Winning, Who’s Hurting and What Canada Should Do

November 22, 2007

Thank you for the opportunity to appear before you this afternoon to discuss the impact of Canada’s rapidly appreciating dollar.

Only a few years ago, we worried about the impact of our low and falling dollar. That weakness reflected our precarious fiscal state and low commodity prices. It sapped our productivity, added to inflationary pressures, left us vulnerable to foreign takeovers. Thinking about that today brings to mind the old adage about being careful what you wish for.

A strong currency has many benefits.  Consumers are enjoying lower prices on goods imported from the United States, and if the dollar stays high, prices will continue to fall as inventory works its way through the system. Businesses also can benefit from falling import prices, especially when it comes to investing in new machinery and equipment, much of it imported from our neighbour to the south. That downward pressure on prices in turn keeps inflation low, and leaves more room for the Bank of Canada to reduce interest rates, a further benefit for both families and businesses.

But make no mistake. Both the current level of the dollar and the incredibly rapid pace of its rise are causing real problems for our economy. In the resource sector, tight labour markets keep driving up costs that have to be paid in Canadian dollars even as the shift in exchange rate takes away much of the global rise in commodity prices that are expressed in U.S. dollars.  Manufacturers already have shed hundreds of thousands of jobs, and the damage in that sector could get much worse.  Exporters of services are affected just as badly, because their biggest cost is people who are paid in Canadian dollars.  This includes Canada’s vital tourism sector, which is being hurt both by the rise of the dollar and increasing security requirements at the United States border.

Perhaps the biggest risk moving forward lies in the causes of the plunge in the American dollar against almost all major currencies.  The United States faces huge fiscal, trade and current account deficits – as Canada did during the dark days of the 1990s. The real danger is that these economic negatives, compounded in recent months by crises in the financial and housing markets, could plunge the United States into recession. A major downturn in our largest export market would compound the damage already being done by the dive in the U.S. dollar.

In the meantime, the worst aspect of the exchange rate situation is not the absolute level of our dollar against its American counterpart, but the speed and volatility of currency movements. Over time, Canadian businesses can offset a higher dollar either by moving operations or purchases offshore or by investing in new technologies that deliver higher quality at lower cost in Canada. But that kind of investment takes time to develop, buy and put in place. At its recent peak of US$1.103, our dollar had risen a stunning 29 percent since the beginning of the year, and 74 percent over the past five years. Even aggressive business investment can’t cope with that speed of change.

So far Canada has done remarkably well in replacing the jobs being lost in manufacturing with jobs in other sectors, ones that on average are better paid. But this performance cannot continue indefinitely in the face of a rising dollar and a weakening United States economy.

The most important step that governments can and must take now is to focus on helping businesses to accelerate the investments that are necessary if we want to keep growing jobs in this country. Successive federal governments have done a good job in steadily bringing down the statutory corporate income tax rate.  But because of the lead times involved in major capital investments, the federal government should extend the faster write-offs for manufacturing equipment introduced in the last budget, and also consider improvements to drivers of innovation such as the Scientific Research and Experimental Development Investment tax credit (SR&ED).

Assistance on the tax front must not be limited to the federal government. Provincial governments must do their share — a task that is most urgent in Canada’s manufacturing heartland of Ontario, which currently suffers under the highest effective tax rate on new investment in the industrialized world. Provinces are gradually reducing their capital taxes, but the most critical next step is for Ontario, British Columbia and other provinces that still levy sales taxes on business inputs to convert to value-added taxes similar too and preferably harmonized with the federal Goods and Services Tax.  Provincial governments also should more quickly to eliminate their remaining capital taxes and to lower their corporate income tax rates.

Tax policy is not the only lever that governments can and should pull if they want Canada’s long run of economic growth to continue through the current crisis in our largest market. They need to tackle every policy that adds unnecessarily to the cost of doing business in this country.  The federal government needs to achieve the goal of the Smart Regulation initiative of a 20 percent cut in the administrative burden of regulation. Federal and provincial governments need to reduce remaining barriers to the movement of goods, services and people across the country, and to ensure that other important policy objectives such as addressing climate change are pursued in ways that add to rather than subtract from our country’s competitiveness. 

Canada also must ensure that people and goods move smoothly into and out of Canada.  This requires investment in transportation and border infrastructure. But it also reinforces the importance of strengthening the efficiency of North America as a whole and making sure that the Canada-United States border stays as open and efficient as possible. An efficient Canada – United States border is critical to the competitiveness of Canadian companies. By the same token, the potential combination of a sticky border with a high Canadian dollar would form a powerful incentive for businesses to put new investment into the United States rather than in Canada.

Cutting taxes on business investment, streamlining regulation and working toward a seamless border are not new prescriptions. They made sense when our dollar was low.  They have become pressing necessities now that our dollar has climbed so far and so fast.