Employment Adjustments in High-Trade-Exposed Manufacturing in Canada

The study presents a model and estimates the dynamic response of employment in high-trade-exposed manufacturing to the Canadian dollar’s appreciation. The evolution of employment shares of high-trade-exposed manufacturing for the 10 provinces from 1987 to 2006 is captured using a general error correction model. This model is estimated using state-of-the-art time-series–cross-sectional (TSCS) data econometrics. The main finding of the study is that a substantial part of the adjustment to the Canadian dollar’s appreciation since 2002 had already been completed in Canadian high-trade-exposed manufacturing industries by July 2007. However, simulation results suggest further employment losses in these industries if the value of the Canadian dollar remains around US$0.95. The reason for these further losses is that employment share does not adjust immediately to movements in the exchange rate. Estimates from the models indicate that between 60 percent and 70 percent of the adjustment to exchange rate movements is completed after two years. Consequently, most of the adjustment that still needs to be done results from the appreciation of the Canadian dollar thus far in 2007. The results also suggest that the effect of movements in the real exchange rate on employment in high-trade-exposed manufacturing is highly heterogeneous across provinces. Not surprisingly, the results suggest that the effect would be greater and particularly significant in Quebec and Ontario. If the dollar remains around US$0.95, simulation results suggest that the proportion of the adjustment that still needs to be done (July 2007) is less in Quebec (between 18 percent and 26 percent) and Ontario (between 27 percent and 33 percent) than in Canada as a whole (between 30 percent and 36 percent). If the Canadian dollar remains at or around parity with the U.S. dollar, the proportion of the adjustment still remaining increases to the 31 percent and 37 percent range for Quebec, 39 percent and 43 percent range for Ontario, and 42 percent and 46 percent range for Canada as a whole. There is a considerable amount of risk involved in simulation exercises of this type. The risks are related to uncertainty regarding the future evolution of two key variables of the models: the value of the Canadian dollar, and the evolution of the U.S. economy. Risk also results from model uncertainty.