Oil price drop: the windfall and the fallout
By Dr. James Stanford, Unifor Economist
A decline in oil prices by half is a major shock for the Canadian macroeconomy. In my judgment—and I actually worked, in another life, as an energy economist for a few years before I joined the union movement—prices are likely to stay at this level or perhaps go even lower in the medium term. I don’t see any quick change in the global forces that drove the price down to the levels that they did.
Also, it’s not at all clear that the current oil price is low by historical standards. In fact, it’s about equal to its 40-year inflation-adjusted average, which suggests that the price in recent years was high rather as opposed to the current price being low. I think we should shape our response to this on the expectation that prices are likely to stay at current levels or lower levels for some time to come.
There are many various and contradictory economic effects from the decline in prices. Petroleum production will not be quickly affected. In fact, Canada’s production is going to keep growing in the medium term. We are seeing a major retrenchment of investment in new exploration and in development and construction projects in the petroleum sector. Since that sector accounted for 30% of businesses’ fixed capital spending in Canada before the decline, this is a major problem for our economy, and there will be big spinoff effects from it.
The real GDP effect will be muted. Extraction will continue to grow, investment will fall, and some other sectors are going to experience benefits, including consumer spending, benefits for energy-consuming industries, especially in the transportation sector and to a small degree in manufacturing itself.
The impact of lower oil prices on demand in the U.S., our major export customer, is unambiguously positive, and that will benefit our economy. There will be some losses among manufacturing companies that supplied the oil and gas industry with manufactured inputs, but as a share of our total manufacturing activity in Canada, that supply chain linkage was small.
The most important beneficial impact, of course, will be the decline in the Canadian dollar, which is now back to its purchasing power parity level. I stress that the dollar today is not low. In fact, the dollar is at its appropriate level, given relative consumer prices in Canada and elsewhere. There will be significant benefits from a lower dollar, both immediate and in the longer run, on net demand for Canadian-made goods and services in all tradable sectors, not just manufacturing, but also tourism and tradable services.
It even helps the petroleum and resource sectors themselves to grapple, by cushioning some of the impact of the decline in world prices. We’re seeing some benefits of that already. For example, Canada’s exports of auto parts grew by 15% last year, which is a very encouraging sign for an industry that has experienced a very challenging decade.
There are some caveats regarding the beneficial impact of the lower dollar.
First of all, the Canadian dollar has not weakened universally. Our dollar has appreciated against the euro, which is a major competitor in manufacturing markets, by 15% over the last year. There has been no change in our dollar relative to the Mexican peso, and Mexico is of course the largest source of imported automotive products to Canada. Our currency has appreciated in the last year against the Japanese yen.
While the lower dollar is beneficial, it’s clearly not a cure-all for our manufacturing problems. Partly because so much capacity was lost during the last decade, it’s difficult for the industry to take advantage of this space that the lower dollar provides.
Second, companies don’t know how long the lower dollar is going to last. I think it is important in this regard for government and the Bank of Canada to indicate their views that in the long run the dollar should not shoot back to levels well above its purchasing power parity; otherwise the potential positive impact of a lower dollar on investment decisions will be muted.
We would stress very much the need for continuing strong, proactive economic strategies to help key strategic sectors, such as auto, aerospace, telecommunications equipment, and also such strategic tradable services as digital media, in which we have a lot of Unifor members working. That will be part of the response.
I think the major economic challenge to Canada’s macroeconomy from lower oil prices is going to be the fallout from retrenchment in petroleum investment, and part of government’s response to that can be very strong support for increased investment, both public and private, in other sectors of the economy. “Public” means support for infrastructure spending. “Private” means partnering with industry to boost investment in key sectors such as those I mentioned.