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Do Exchange Rates Affect the Capital-Labour Ratio? Panel Evidence from Canadian Manufacturing Industries

  • Danny Leung
  • Terence Yuen

Using industry-level data for Canadian manufacturing industries from 1981 to 1997, the authors find empirical evidence of a negative relationship between the capital-labour ratio and the user cost of capital relative to the price of labour. A 10 per cent increase in the user cost of the machinery and equipment (M&E) relative to the price of labour results in a 3.3 per cent decrease in the M&E-labour ratio in the long run. Assuming complete exchange rate pass-through into imported M&E prices, the maximum effect of a permanent 10 per cent depreciation in the exchange rate is a 5.2 per cent increase in the user cost of M&E, and a 1.7 per cent decline in the M&E-labour ratio. This result implies that the cumulative growth of the M&E-labour ratio during the 1991–97 period would have been 2.3 percentage points higher had the dollar not depreciated. This may appear to be significant, but, considering that M&E as a share of total capital and capital's share of nominal output are both approximately one-third, in terms of a simple growth accounting framework, the effect on labour productivity is small.

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Paper provided by Bank of Canada in its series Staff Working Papers with number 05-12.

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Length: 60 pages
Date of creation: 2005
Date of revision:
Handle: RePEc:bca:bocawp:05-12
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