Canadian labor productivity and Oil Prices: An Observation

(This is a long blog – sorry about that because initially I was only going to talk about oil, but then it dawned on me that the issue is what will be the impact of higher oil prices on the Canadian economy because of international competition issues)

In 2007, oil prices peaked at over $140 per barrel.  Most blamed speculators for this meteoric rise in prices, but one inescapable fact is that in the short term oil demand is inelastic, and oil supply is not growing nearly as fast as demand.  Overtime consumers can modify their behavior to accommodate rising oil prices, but in the short term they cannot.

 

The International Energy Agency (“IEA”) predicted that be 2011 global oil demand will reach 87.8 billion barrel per day – the previous peak in 2007 was around 86.5 billion.  Since the OECD demand has dropped from a high of nearly 50 billion barrel to 45 billion, a 10% drop, but non-OECD countries saw demand rise from 35 billion to 43 billion barrels over the same period (23%).  On the bright side supply is also expanding, but if non-OECD demand continues its current trend oil prices only have one to do, and its up.  Global production is rising by slightly less than 2% per annum, but on its current trend demand is rising by more than 3% per annum, excluding OECD countries demand which flat.  All of Asia is in growth phase, recession in China is considered at sub 10% annual GDP growth.  Finally, as of July 2010, the world’s largest energy user is China, America has been supplanted by a nation 5x larger (in population terms).

 

According to the IEA, Canada’s oil proven oil reserves are second only to those of Saudi Arabia.  Canada is one of the world’s largest oil exporters (#14 in 2006, #6 in 2008, # 5 in 2009), and after the disaster in the gulf of Mexico, demand for oil sands is certain to grow.

Most Canadian economist see the Canadian dollar (the “loonie”) at parity and beyond against the US dollar.  In fact, the two main drivers of a strong dollar (positive correlation) are the S&P 500 and oil prices.  The rest of Canada’s economy may not be so keen on a further strong appreciation of the Canadian dollar, Scotia Capital had the loonie at 1.10 in 2012, about 13% higher than it is today.  It is often forgotten that the Canadian dollar traded at a low of 0.62 in 2002, so that over a decade the Canadian dollar has nearly doubled in value (177%) against the US dollar.

My point is that whatever happens in the G7 or G8 is now irrelevant as far as Canada is concerned, the Canadian dollar will continue to rise as oil prices continue to rise.  The implication for labor costs in Canada is dire, unless Canada can address its long standing difficulties with raising productivity.  As of June 2010, Canadian productivity still lags that of America, although the differential is not as bad as it used to be, as in March 2010, Canadian productivity rose by 9%, bringing Canadian productivity to a level identical to America in 2003.

 

   (Source: National Bank of Canada)

In fact, the trade results seem to confirm this because although the Canadian trade deficit grew in June, both imports and exports rose dramatically.  Canadian industry now fully realizes that the strong Canadian dollar is here to stay, and that productivity increase is the only way they will remain competitive.

There are four factors which drive productivity; Canada has structural weakness in two of the four:

(1)               Innovation and Technology:  Canada is a small open economy.  Its small size, labor market inflexibility and stronger union make this force weaker in Canada.

(2)               Specialist knowledge workers;  Canada is a country of generalist, specialists are often attracted away from Canada to other markets

(3)               Reallocation of resources:  Canada has suffered far fewer, and less severe recessions – creative destruction has had less impact here.

(4)               Globalization as a tool of market expansion:  Canada, is one of the world’s most open economies, and should be able to improve productivity because of its growing markets.

Canada’s disadvantage because of a stronger currency can only be alleviated by better productivity.  A constant headache for Canadian policy makers, who have noted that for years Canadian labor productivity has lagged that of the US.  The number of studies on Canadian productivity’s shortfall is too numerous to count. 

Policy has tried to accommodate the needs of industry, remove impediments to increased productivity.  Maybe the treat of a stronger dollar is the only real incentive to Canadian entrepreneurs to increase productivity.